Eurobonds Behind Euro$ #5’s Collateral Case

What is it?

Let’s roll the clock back to the landmine of 2018. Collateral shortage, financial chaos, rising dollar and all that stuff.

But, Argentina has been an absolute darling, a media frenzy and Wall Street hero.

Since 2016, the Eurobond market had embraced this long-shunned section of South America. Where before this poor country couldn’t sell one single dollar in securities no matter how high the coupon attached, in 2017 in particular the world couldn’t get enough Argentine paper at any price.

In the context of securities lending, that would’ve meant right around the end of 2017 Argentine debt almost certainly was given more favorable terms (in securities lending) than it should have ever been afforded. I don’t know for sure if it was subprime MBS-like friendly, but undoubtedly way too far in the same direction. Argentina bonds were great because everyone loved Argentina.

A Eurobond is simply a debt instrument issued outside the home country of the borrower (who could also be a private non-financial company, not just sovereigns or banks). Typically denominated in US dollars, the borrowing could be in whichever currency the obligor requires at the time (usually dollars).

Sounds simple enough, but there’s more. Here’s a pretty straightforward sketch behind “more” and where it all intersects with repo, collateral, the real fun stuff:

During 2017’s “globally synchronized growth” fiasco, Eurobond investors and the dealer banks who sit in between all the heavy financial arrangements got drunk on central bank assurances that the “growth” part was real this time.

Spoiler: it wasn’t. In never is; false dawns only.

Realizing this, a chain reaction triggers for a whole bunch more than Argentina Eurobonds: when everyone loved Argentina and “globally synchronized growth”, that and so much other junk was let infect the global collateral stream. Transformations as shown above along with straight up use as collateral, much supported by shake-your-head quality credit.

Then, 2018, they didn’t love Argentina; collateral shortage system-wide as haircuts got adjusted and collateral calls (May 29, 2018) issued for better quality (USTs and the like). Once that becomes clear, everything on the chart above must reverse. The dealer (Bank B) isn’t going to accept the Argentine Eurobond as collateral in its collateral-for-collateral swap delivering the Insurance Company C’s UST. This leaves Argentina Bank A exposed, unable to rollover in US$ repo unless it can somehow find better collateral to post to repo or to swap.

On the other side of it, however, history apparently repeated because the Eurobond market is either truly that stupid or so plain gullible combined with short-termism and an unreasonable ability to rationalize central bank promises and projections.

What do I mean? In late 2020 and early 2021, maybe Argentina wasn’t back in the Eurobond game…but a whole bunch of others came to be, including some of the worst credits in Africa. Countries like Ghana and Zambia have been issuing Eurobonds almost like Argentina once did.

Having floated billions last year, the Ghanian government today complains repeatedly that its Eurobonds have been unfairly singled out, having crashed for reasons beyond fundamentals. Officials there, of course, blame the Federal Reserve and its “rate hikes” because they like everyone else including the entire financial media has been taught to think only in those terms; if something happens, must be central bank.

The problem is collateral, not Jay Politics Powell.

How do we know? Let’s check the spreads.

First up, a control of sorts, one from South Africa which is one of the better-quality credits floating around the offshore marketplace.

Among Africa’s lesser quality issuers, however, it’s definitely not FOMC policy behind bond plunges. And while I don’t have any Eurobonds from Ghana or Zambia to show you, I can choose a number from Egypt which will stand in just fine for those.

First off, a higher coupon because of its perceived higher risk that eventually offers no shelter once the system goes astray.

Those two time periods – October and December – should ring all sorts of bells where the systemic collateral condition has been concerned.

In fact, you can compare the spread on Egypt’s one Eurobond to others that are more generalized, such as ICE’s option-adjusted calculation for emerging market corporates as a group. The chart immediately above looks quite a lot like the one immediately below.

This spread widening throughout weaker-quality collateral instruments has also and already spilled over into domestic issued corporate junk, if not yet with the same amount of puking.

That center isn’t the Fed nor its inert, useless bank reserves, rather the herding instincts of increasingly risk averse dealers who more and more will only deal in the better issues of collateral the more this thing, Euro$ #5, keeps going.

Back in the middle of 2018, even the rate-hiking hawks of the FOMC couldn’t help but acknowledge the sudden “strong worldwide demand for safe assets” as officials called it (trying to downplay the whole thing).

They never could quite figure out why. Safe, yes, but more so highly and dependably liquid.

The collateral multiplier had shrunk once the real monetary system rethought and then repriced if not rejected so much stupid junk.