mick silver
6th September 2011, 12:43 PM
http://www.acting-man.com/?p=10013 ...
A while back we discussed a specific problem inherent in the EU/IMF bailout of Greece, Portugal and Ireland that has very likely exacerbated the crisis in their bond markets. The bailouts were originally thought to be a 'stop gap' measure until these governments were able to return to the markets for financing their debt. The problem is that the IMF and EFSF bailout loans have priority relative to the existing debt outstanding. Since the holders of the government bonds issued prior to the bailouts are no longer the most senior creditors, their expected recoveries in the event of a default will be commensurately lower. On the one hand, the bailout efforts are shifting more and more debt onto the tax payer financed entities as existing debt matures, on the other hand, the greater the amounts lent out by these entities, the lower the expected recoveries for the remaining outstanding pre-bailout bonds will be if a default occurs anyway. Consequently the decision to provide the bailout funds has almost certainly put additional pressure on the prices of bonds issued by the governments concerned.
This problem has been brought to the fore again late last week when the IMF noted its opposition to the idea that Greece should provide collateral in exchange for receiving bailout funds. If Greece were to accede to Finland's demand for collateral, or agree to any other, wider collateral provision involving several or all euro area nations, the IMF's seniority with respect to post default recoveries would obviously no longer be assured. In so many words, the IMF will probably not be able to continue lending money to Greece if a collateral facility is put in place.
As Bloomberg reports (http://www.bloomberg.com/news/2011-09-02/imf-said-to-oppose-push-for-greek-collateral.html):
“ The International Monetary Fund (http://topics.bloomberg.com/international-monetary-fund/) opposes European plans to force Greece to put up collateral in its second rescue, said four people with direct knowledge of the matter.
The use of collateral, a concession to win Finland’s backing for 109 billion euros ($155 billion) of loans pledged by euro leaders in July, would deny the IMF priority creditor status and violate Greek bondholders’ rights, said the people, who declined to be named because the talks are in progress.
IMF objections threaten to snag Europe (http://topics.bloomberg.com/europe/)’s crisis-management effort after aid of 256 billion euros for Greece, Ireland and Portugal failed to restore order.”
(emphasis added)
The implication of this objection seems clear.
It should be added that the IMF's 'priority creditor status' by itself already violates the rights of existing Greek bondholders, but obviously the potential recoveries of said bondholders in the event of default would be still lower if the collateral agreement were implemented.
There are therefore two reasons for the continued crash in Greek government bonds:
1.Finland's demand for collateral increases the probability that the bailout will not be implemented at all, which will result in a default, and
2.in the event that the bailout proceeds after a collateral facility acceptable to all euro area members has been established, existing bondholder will recover even less if a default happens down the road anyway.
What a mess.
Miffed Troika
Meanwhile, the 'troika' (EU/ECB/IMF) review of Greece's progress in complying with the bailout conditions – a process that is regularly repeated prior to new loan disbursements – has been interrupted, amid a dispute over 'fresh gaps opening in Greece's government budget deficit'.
As the WSJ reports (http://online.wsj.com/article/SB10001424053111904583204576545811058225074.html):
“The suspension of the talks in Athens between the government and a group of officials representing the providers of Greece's bailout cash came, officials said, amid a dispute about how to address new gaps opening up in the government budget deficit.
"The Greek side insisted the missed targets are the result of the recession. The troika said recession played a part, but Greece basically didn't keep up with its commitments, so more measures will be needed to make up for the lost ground," said a person with direct knowledge of the talks.
"There is a clear disagreement that can't be bridged today," the person added.
The talks with the so-called troika—representatives of the International Monetary Fund, European Central Bank and European Commission—began earlier this week and were expected to be concluded by Sept. 5. According to a Greek government official, the delegation is now expected to return in about 10 days, after the government has prepared a draft of its 2012 budget.
On the talks hangs a payout of €8 billion ($11.5 billion) of rescue funds under the €110 billion package arranged last year, needed to ensure the government pays its way. Greece has negotiated a further official rescue package of more than €100 billion, meant to tide it through 2014, which has yet to be formally agreed by lenders.
"I expect a hard default definitely before March, maybe this year, and it could come with this program review," said a senior IMF economist who is keeping close tabs on the situation. "The chances for a second program are slim."
Failure of Greece to meet its targets, growing reluctance by some euro members to continue lending and the fact that private-sector participation in a second bailout won't significantly alter Greece's debt profile are the primary factors, the IMF official said.”
(emphasis added)
This certainly sounds as though the market's assessment of the situation (i.e., default is all but certain) will turn out to be correct. Note however that the official statement (http://www.ecb.europa.eu/press/pr/date/2011/html/pr110902.en.html) on the interruption of the review makes it sound as though it was all about a tiny technicality not really worth worrying about ('move along, there's nothing to see here').
“A joint EC/ECB/IMF team has been discussing recent economic developments and reviewing policy implementation in the context of the fifth review of Greece's economic programme. The mission has made good progress, but has temporarily left Athens to allow the authorities to complete technical work, among other things, related to the 2012 budget and growth-enhancing structural reforms. The mission expects to return to Athens by mid-September, when we expect the Greek authorities to have completed the technical work, to continue discussions on policies needed to complete the review.”
In other news, a certain bridge in Brooklyn is up for sale again.
Not surprisingly, Greek government bond yields have continued to soar, with the one year yield jumping by nearly 1100 basis point in Friday's trading alone, to a new high of 72.04%. The two year yield also jumped to a new high just above 47%, a rise of just a little over 400 basis points on the day. The inversion of the Greek yield curve is becoming ever steeper.
http://www.acting-man.com/blog/media/2011/09/Greece-one-year-yield.png (http://www.acting-man.com/blog/media/2011/09/Greece-one-year-yield.png)
Greece's one year government note yield jumps to over 72% on Friday – click for higher resolution.
http://www.acting-man.com/blog/media/2011/09/Greek-yields-composite.jpg (http://www.acting-man.com/blog/media/2011/09/Greek-yields-composite.jpg)
An overview of Greek one, two and ten year government bond yields as of last Friday – click for higher resolution.
EFSF Ratification Trouble & Dangerous Timetables
Recently reports in the media have gone back and forth between stating that Mrs. Merkel faces a potential 'revolt' in her own governing coalition against ratification of the latest bailout deal, to stating that she has things well in hand by employing well-worn scare tactics to bring members of parliament into line (the old 'we shall all perish if we don't throw even more tax payer money at bankrupt entities' ploy).
The latest development is that the Free Democrats apparently insist that the German Bundestag needs to have veto power (http://www.bloomberg.com/news/2011-08-27/german-fdp-wants-veto-anchored-in-efsf-operations-bild-says.html) over EFSF decisions in exchange for approving the expansion of the rescue fund. In short, it appears now that the bill's smooth sailing envisaged only a short while ago may turn out to be nothing but wishful thinking after all.
According to Bloomberg (http://www.bloomberg.com/news/2011-08-27/german-fdp-wants-veto-anchored-in-efsf-operations-bild-says.html):
“The German parliament must have the right to approve all aid petitions made to the rescue fund and the weight of its decisions to be reflected in the fund’s actions, the newspaper reported today, citing unidentified FDP officials.
If a petition fails to gain a clear parliamentary majority Germany’s representative on the fund’s ruling board must be forced to reject the petition rather than abstain, Bild reported, citing the officials.
The Germany government aims to have the bill to expand the toolbox of the European Financial Stability Facility on the statute books by the end of September.”
Now consider that on September 7, the German constitutional court will issue its ruling on the bailout complaints. As we have noted previously (http://www.acting-man.com/?p=8504) in this context, the vast deterioration in the social mood occasioned by the post bubble secular economic contraction and the fact that the complainants are correct in both their economic and legal assessment of the situation makes a 'surprise ruling' much more likely this time around. Specifically, we think it possibly that the court will insist on precisely the type of thing the FDP wants to have: more democratic control of the bailout process through the German Bundestag.
The month of September is in fact home to a great many events that could potentially upset the markets further. The first event that was originally scheduled for September 5 was the conclusion of the 'Troika's' review of the Greek budget. This as we have seen has already been postponed, to devastating effect.
On September 8, we have the next ECB meeting, a meeting that is likely to disappoint, as ECB president Trichet is unlikely to do an immediate about-face and ease monetary policy again after just having hiked rates twice – in spite of the fact that markets are already pricing in renewed easing in view of the recent rapid deterioration in economic growth.
September 9 is the deadline for the planned Greek debt exchange, i.e., the private sector contribution to the bailout, which due to its allegedly 'voluntary' nature requires the rigmarole of banks officially 'expressing their interest in participation'. Greece has let it be known that anything less than 90% participation by creditors would be deemed insufficient for the plan to go forward.
September 15 is the day when the next disbursement of EFSF bailout funds to Ireland and Portugal is due. This is likely to happen without a hitch, but then again, there lately has been quite a tendency for Murphy's law to strike unexpectedly.
The next FOMC meeting is taking place on September 20-21; we think by that time there could be enough panic in the markets to induce the committee of central planners to go for the pump priming equivalent of 'shock and awe' – especially after the truly dismal jobs report released last Friday. As we have noted before, the possibility that the markets will just 'yawn' and sell off anyway should not be dismissed out of hand.
On September 29, the German Bundestag will vote on the new EFSF/ bailout ratification. This promises to be quite riveting this time.
What else is going to happen during September? Well, for one thing, Italy must roll over about € 45 billion in debt. That could prove to be quite a problem, especially if market turmoil persists. Italian bond yields are once again soaring, following a decrease in ECB intervention and the Berlusconi government's recent backtracking on the austerity package. This has led to ECB president Trichet publicly admonishing Italy's government in an attempt to bring it back into line. According to Bloomberg (http://www.bloomberg.com/news/2011-09-02/trichet-says-italy-must-confirm-commitment-to-aug-5-austerity-measures.html):
“European Central Bank President Jean-Claude Trichet said Italy (http://topics.bloomberg.com/italy/) must confirm its commitment to the “overall goal” it announced on Aug. 5 to reduce its budget deficit (http://topics.bloomberg.com/budget-deficit/).
“These measures decided by the government in its announcement on 5 August are of extreme importance to rapidly reduce public finance deficits and enhance the flexibility of the Italian economy,” Trichet said in an interview with Il Sole 24 Ore (http://topics.bloomberg.com/il-sole-24-ore/), according to a text published by the Frankfurt-based ECB. “It is therefore of the essence that the overall goal in terms of the public finance improvement that was announced be fully confirmed and substantiated.”
Italian Prime Minister Silvio Berlusconi (http://topics.bloomberg.com/silvio-berlusconi/) on Aug. 29 agreed to overhaul the 45 billion-euro ($66 billion) austerity plan of Aug. 5, which had helped persuade the ECB to start buying Italy’s bonds. While the full impact of the changes remain unclear, Berlusconi dropped a tax on the highest earners and limited funding cuts to regional governments to appease the Northern League (http://topics.bloomberg.com/northern-league/), a key coalition ally opposed to parts the original plan that aimed to balance the budget in 2013.
Finance Minister Giulio Tremonti (http://topics.bloomberg.com/giulio-tremonti/) said yesterday that a planned crackdown on tax evasion (http://topics.bloomberg.com/tax-evasion/) will offset lost revenue from a levy on higher earners dropped from the package. The ECB is watching with “great concern” how Italy progresses with budget cuts, Governing Council member Ewald Nowotny told reporters last night.”
(emphasis added)
We believe Silvio Berlusconi is a tough-as-nails politician with no scruples whatsoever. Embarrassment isn't even part of his vocabulary. Just look at how many legal troubles he has survived and what methods he employed in doing so. As we have previously suggested (http://www.acting-man.com/?p=9979), he may have simply intuited that he is actually the one who holds all the trump cards in this particular game of nerves. After all, the ECB is likely well aware that if Italy's bond yields were to exceed the 'bailout threshold' level established when the 'GIP' trio went belly-up, it will be all over but the shouting. Consequently Berlusconi may be calculating that the ECB will do whatever is necessary to avert this scenario. He may well be right about the ECB, alas he may be underestimating the power of the markets to overrule such interventions.
September Could Be Brutal – And May Produce Buying Opportunities
Speaking of the markets – here is precisely the problem with the timetable we have just outlined. We believe the markets simply do not have the patience to wait and see what may or may not happen. In today's world of inter- and intra-market hyper-correlation between 'risk assets', with a great many large hedge funds already nursing big losses after the plunge in stock markets and commodities during August, there are probably a great many itchy trigger fingers out there.
We keep hearing how a 'repeat of 2008 is impossible' and admittedly there are a number of well-reasoned arguments that would seem to favor that view. Primarily we would cite the enormous growth in US money supply that we have recently observed. However, we are concerned by this widespread consensus. Consider that the most recent month for which we have reliable money supply growth statistics is the month of July – a month during which money supply growth went 'off the charts' as the saying goes. And yet, the markets for risk assets plunged in July and August. There is no telling how big a lag there will be before the money supply growth shows an effect aside from the one it has already exerted on the gold price.
The question one must ask is this: are the obvious risks (not to mention the unknown ones) adequately discounted already? We would be far more confident that they have indeed been discounted if there were abject fear in the markets. Alas, we do not detect such abject fear as of yet. On the contrary, the vast majority of market commentary seems focused on the 'dip buying opportunity'. As we have pointed out all year long, indicators of sentiment that have proven long term significance, such as the mutual fund cash-to-assets ratio and total margin debt have been in 'red alert' territory for many months. One should thus probably spend more time on pondering what could go wrong than on the alleged dip buying opportunities. However, as you will see further below, we do believe investors should begin to consider the opportunities that may present themselves in European markets over coming weeks.
One of the signs that risk is extremely high is the run-up in CDS on the debt of major European banks. The sovereign debt crisis continues to unrelentingly redound on the fractionally reserved and clearly under-capitalized euro area banks.
http://www.acting-man.com/blog/media/2011/09/eurobankcds1.gif (http://www.acting-man.com/blog/media/2011/09/eurobankcds1.gif)
A simply arithmetic composite chart (unweighted) of CDS on BBVA, Deutsche Bank, SocGen, BNP Paribas, Intesa Sanpaolo, Monte dei Paaschi di Siena, and Unicredito. As can be seen, these CDS prices are way above their 2008/9 crisis highs by now – click for higher resolution.
As we have noted on several occasions, interbank and wholesale funding is increasingly drying up in the euro-area. The ECB is taking over an ever greater share of bank funding as silent bank runs are engulfing banks in the PIIGS nations, with more and more banks seeing questions raised about the counterparty risk they pose. What if the banking system suffers a serious seizure that requires even more forceful, panicked ad-hoc measures by the ECB to keep the system of payments going? Can anyone rule something like that out if e.g. Greece were to actually default? Is this risk adequately discounted? Of course we don't know whether it is or isn't, but we kind of doubt it. Meanwhile, euro basis swaps continue to indicate that stresses in connection with dollar funding in the euro area banking system are worsening.
http://www.acting-man.com/blog/media/2011/09/eurobasisswaps1.gif (http://www.acting-man.com/blog/media/2011/09/eurobasisswaps1.gif)
Three month, one year and five year euro basis swaps. Note the continued deterioration in the shorter term swaps to levels associated with previous iterations of the crisis – click for higher resolution.
In addition to the foregoing we would note that the charts of most stock markets simply look terrible. Germany's DAX index specifically is best described as a horror-show. We have previously warned that the consolidation following the initial weave of heavy selling looks like some sort of running correction. It still looks that way, although no new low has been produced yet, so alternative (and hence more short term bullish) interpretations can not be ruled out yet. Nonetheless, this is an ugly chart no matter which way one slices it. The biggest concern must be the weakness exhibited in the recent bounce attempts and the ease with which very large sell-offs have tended to occur. For instance, Friday's decline doesn't look like much on the chart, but it was actually a quite considerable plunge of 3.4%. ....... there more at link
A while back we discussed a specific problem inherent in the EU/IMF bailout of Greece, Portugal and Ireland that has very likely exacerbated the crisis in their bond markets. The bailouts were originally thought to be a 'stop gap' measure until these governments were able to return to the markets for financing their debt. The problem is that the IMF and EFSF bailout loans have priority relative to the existing debt outstanding. Since the holders of the government bonds issued prior to the bailouts are no longer the most senior creditors, their expected recoveries in the event of a default will be commensurately lower. On the one hand, the bailout efforts are shifting more and more debt onto the tax payer financed entities as existing debt matures, on the other hand, the greater the amounts lent out by these entities, the lower the expected recoveries for the remaining outstanding pre-bailout bonds will be if a default occurs anyway. Consequently the decision to provide the bailout funds has almost certainly put additional pressure on the prices of bonds issued by the governments concerned.
This problem has been brought to the fore again late last week when the IMF noted its opposition to the idea that Greece should provide collateral in exchange for receiving bailout funds. If Greece were to accede to Finland's demand for collateral, or agree to any other, wider collateral provision involving several or all euro area nations, the IMF's seniority with respect to post default recoveries would obviously no longer be assured. In so many words, the IMF will probably not be able to continue lending money to Greece if a collateral facility is put in place.
As Bloomberg reports (http://www.bloomberg.com/news/2011-09-02/imf-said-to-oppose-push-for-greek-collateral.html):
“ The International Monetary Fund (http://topics.bloomberg.com/international-monetary-fund/) opposes European plans to force Greece to put up collateral in its second rescue, said four people with direct knowledge of the matter.
The use of collateral, a concession to win Finland’s backing for 109 billion euros ($155 billion) of loans pledged by euro leaders in July, would deny the IMF priority creditor status and violate Greek bondholders’ rights, said the people, who declined to be named because the talks are in progress.
IMF objections threaten to snag Europe (http://topics.bloomberg.com/europe/)’s crisis-management effort after aid of 256 billion euros for Greece, Ireland and Portugal failed to restore order.”
(emphasis added)
The implication of this objection seems clear.
It should be added that the IMF's 'priority creditor status' by itself already violates the rights of existing Greek bondholders, but obviously the potential recoveries of said bondholders in the event of default would be still lower if the collateral agreement were implemented.
There are therefore two reasons for the continued crash in Greek government bonds:
1.Finland's demand for collateral increases the probability that the bailout will not be implemented at all, which will result in a default, and
2.in the event that the bailout proceeds after a collateral facility acceptable to all euro area members has been established, existing bondholder will recover even less if a default happens down the road anyway.
What a mess.
Miffed Troika
Meanwhile, the 'troika' (EU/ECB/IMF) review of Greece's progress in complying with the bailout conditions – a process that is regularly repeated prior to new loan disbursements – has been interrupted, amid a dispute over 'fresh gaps opening in Greece's government budget deficit'.
As the WSJ reports (http://online.wsj.com/article/SB10001424053111904583204576545811058225074.html):
“The suspension of the talks in Athens between the government and a group of officials representing the providers of Greece's bailout cash came, officials said, amid a dispute about how to address new gaps opening up in the government budget deficit.
"The Greek side insisted the missed targets are the result of the recession. The troika said recession played a part, but Greece basically didn't keep up with its commitments, so more measures will be needed to make up for the lost ground," said a person with direct knowledge of the talks.
"There is a clear disagreement that can't be bridged today," the person added.
The talks with the so-called troika—representatives of the International Monetary Fund, European Central Bank and European Commission—began earlier this week and were expected to be concluded by Sept. 5. According to a Greek government official, the delegation is now expected to return in about 10 days, after the government has prepared a draft of its 2012 budget.
On the talks hangs a payout of €8 billion ($11.5 billion) of rescue funds under the €110 billion package arranged last year, needed to ensure the government pays its way. Greece has negotiated a further official rescue package of more than €100 billion, meant to tide it through 2014, which has yet to be formally agreed by lenders.
"I expect a hard default definitely before March, maybe this year, and it could come with this program review," said a senior IMF economist who is keeping close tabs on the situation. "The chances for a second program are slim."
Failure of Greece to meet its targets, growing reluctance by some euro members to continue lending and the fact that private-sector participation in a second bailout won't significantly alter Greece's debt profile are the primary factors, the IMF official said.”
(emphasis added)
This certainly sounds as though the market's assessment of the situation (i.e., default is all but certain) will turn out to be correct. Note however that the official statement (http://www.ecb.europa.eu/press/pr/date/2011/html/pr110902.en.html) on the interruption of the review makes it sound as though it was all about a tiny technicality not really worth worrying about ('move along, there's nothing to see here').
“A joint EC/ECB/IMF team has been discussing recent economic developments and reviewing policy implementation in the context of the fifth review of Greece's economic programme. The mission has made good progress, but has temporarily left Athens to allow the authorities to complete technical work, among other things, related to the 2012 budget and growth-enhancing structural reforms. The mission expects to return to Athens by mid-September, when we expect the Greek authorities to have completed the technical work, to continue discussions on policies needed to complete the review.”
In other news, a certain bridge in Brooklyn is up for sale again.
Not surprisingly, Greek government bond yields have continued to soar, with the one year yield jumping by nearly 1100 basis point in Friday's trading alone, to a new high of 72.04%. The two year yield also jumped to a new high just above 47%, a rise of just a little over 400 basis points on the day. The inversion of the Greek yield curve is becoming ever steeper.
http://www.acting-man.com/blog/media/2011/09/Greece-one-year-yield.png (http://www.acting-man.com/blog/media/2011/09/Greece-one-year-yield.png)
Greece's one year government note yield jumps to over 72% on Friday – click for higher resolution.
http://www.acting-man.com/blog/media/2011/09/Greek-yields-composite.jpg (http://www.acting-man.com/blog/media/2011/09/Greek-yields-composite.jpg)
An overview of Greek one, two and ten year government bond yields as of last Friday – click for higher resolution.
EFSF Ratification Trouble & Dangerous Timetables
Recently reports in the media have gone back and forth between stating that Mrs. Merkel faces a potential 'revolt' in her own governing coalition against ratification of the latest bailout deal, to stating that she has things well in hand by employing well-worn scare tactics to bring members of parliament into line (the old 'we shall all perish if we don't throw even more tax payer money at bankrupt entities' ploy).
The latest development is that the Free Democrats apparently insist that the German Bundestag needs to have veto power (http://www.bloomberg.com/news/2011-08-27/german-fdp-wants-veto-anchored-in-efsf-operations-bild-says.html) over EFSF decisions in exchange for approving the expansion of the rescue fund. In short, it appears now that the bill's smooth sailing envisaged only a short while ago may turn out to be nothing but wishful thinking after all.
According to Bloomberg (http://www.bloomberg.com/news/2011-08-27/german-fdp-wants-veto-anchored-in-efsf-operations-bild-says.html):
“The German parliament must have the right to approve all aid petitions made to the rescue fund and the weight of its decisions to be reflected in the fund’s actions, the newspaper reported today, citing unidentified FDP officials.
If a petition fails to gain a clear parliamentary majority Germany’s representative on the fund’s ruling board must be forced to reject the petition rather than abstain, Bild reported, citing the officials.
The Germany government aims to have the bill to expand the toolbox of the European Financial Stability Facility on the statute books by the end of September.”
Now consider that on September 7, the German constitutional court will issue its ruling on the bailout complaints. As we have noted previously (http://www.acting-man.com/?p=8504) in this context, the vast deterioration in the social mood occasioned by the post bubble secular economic contraction and the fact that the complainants are correct in both their economic and legal assessment of the situation makes a 'surprise ruling' much more likely this time around. Specifically, we think it possibly that the court will insist on precisely the type of thing the FDP wants to have: more democratic control of the bailout process through the German Bundestag.
The month of September is in fact home to a great many events that could potentially upset the markets further. The first event that was originally scheduled for September 5 was the conclusion of the 'Troika's' review of the Greek budget. This as we have seen has already been postponed, to devastating effect.
On September 8, we have the next ECB meeting, a meeting that is likely to disappoint, as ECB president Trichet is unlikely to do an immediate about-face and ease monetary policy again after just having hiked rates twice – in spite of the fact that markets are already pricing in renewed easing in view of the recent rapid deterioration in economic growth.
September 9 is the deadline for the planned Greek debt exchange, i.e., the private sector contribution to the bailout, which due to its allegedly 'voluntary' nature requires the rigmarole of banks officially 'expressing their interest in participation'. Greece has let it be known that anything less than 90% participation by creditors would be deemed insufficient for the plan to go forward.
September 15 is the day when the next disbursement of EFSF bailout funds to Ireland and Portugal is due. This is likely to happen without a hitch, but then again, there lately has been quite a tendency for Murphy's law to strike unexpectedly.
The next FOMC meeting is taking place on September 20-21; we think by that time there could be enough panic in the markets to induce the committee of central planners to go for the pump priming equivalent of 'shock and awe' – especially after the truly dismal jobs report released last Friday. As we have noted before, the possibility that the markets will just 'yawn' and sell off anyway should not be dismissed out of hand.
On September 29, the German Bundestag will vote on the new EFSF/ bailout ratification. This promises to be quite riveting this time.
What else is going to happen during September? Well, for one thing, Italy must roll over about € 45 billion in debt. That could prove to be quite a problem, especially if market turmoil persists. Italian bond yields are once again soaring, following a decrease in ECB intervention and the Berlusconi government's recent backtracking on the austerity package. This has led to ECB president Trichet publicly admonishing Italy's government in an attempt to bring it back into line. According to Bloomberg (http://www.bloomberg.com/news/2011-09-02/trichet-says-italy-must-confirm-commitment-to-aug-5-austerity-measures.html):
“European Central Bank President Jean-Claude Trichet said Italy (http://topics.bloomberg.com/italy/) must confirm its commitment to the “overall goal” it announced on Aug. 5 to reduce its budget deficit (http://topics.bloomberg.com/budget-deficit/).
“These measures decided by the government in its announcement on 5 August are of extreme importance to rapidly reduce public finance deficits and enhance the flexibility of the Italian economy,” Trichet said in an interview with Il Sole 24 Ore (http://topics.bloomberg.com/il-sole-24-ore/), according to a text published by the Frankfurt-based ECB. “It is therefore of the essence that the overall goal in terms of the public finance improvement that was announced be fully confirmed and substantiated.”
Italian Prime Minister Silvio Berlusconi (http://topics.bloomberg.com/silvio-berlusconi/) on Aug. 29 agreed to overhaul the 45 billion-euro ($66 billion) austerity plan of Aug. 5, which had helped persuade the ECB to start buying Italy’s bonds. While the full impact of the changes remain unclear, Berlusconi dropped a tax on the highest earners and limited funding cuts to regional governments to appease the Northern League (http://topics.bloomberg.com/northern-league/), a key coalition ally opposed to parts the original plan that aimed to balance the budget in 2013.
Finance Minister Giulio Tremonti (http://topics.bloomberg.com/giulio-tremonti/) said yesterday that a planned crackdown on tax evasion (http://topics.bloomberg.com/tax-evasion/) will offset lost revenue from a levy on higher earners dropped from the package. The ECB is watching with “great concern” how Italy progresses with budget cuts, Governing Council member Ewald Nowotny told reporters last night.”
(emphasis added)
We believe Silvio Berlusconi is a tough-as-nails politician with no scruples whatsoever. Embarrassment isn't even part of his vocabulary. Just look at how many legal troubles he has survived and what methods he employed in doing so. As we have previously suggested (http://www.acting-man.com/?p=9979), he may have simply intuited that he is actually the one who holds all the trump cards in this particular game of nerves. After all, the ECB is likely well aware that if Italy's bond yields were to exceed the 'bailout threshold' level established when the 'GIP' trio went belly-up, it will be all over but the shouting. Consequently Berlusconi may be calculating that the ECB will do whatever is necessary to avert this scenario. He may well be right about the ECB, alas he may be underestimating the power of the markets to overrule such interventions.
September Could Be Brutal – And May Produce Buying Opportunities
Speaking of the markets – here is precisely the problem with the timetable we have just outlined. We believe the markets simply do not have the patience to wait and see what may or may not happen. In today's world of inter- and intra-market hyper-correlation between 'risk assets', with a great many large hedge funds already nursing big losses after the plunge in stock markets and commodities during August, there are probably a great many itchy trigger fingers out there.
We keep hearing how a 'repeat of 2008 is impossible' and admittedly there are a number of well-reasoned arguments that would seem to favor that view. Primarily we would cite the enormous growth in US money supply that we have recently observed. However, we are concerned by this widespread consensus. Consider that the most recent month for which we have reliable money supply growth statistics is the month of July – a month during which money supply growth went 'off the charts' as the saying goes. And yet, the markets for risk assets plunged in July and August. There is no telling how big a lag there will be before the money supply growth shows an effect aside from the one it has already exerted on the gold price.
The question one must ask is this: are the obvious risks (not to mention the unknown ones) adequately discounted already? We would be far more confident that they have indeed been discounted if there were abject fear in the markets. Alas, we do not detect such abject fear as of yet. On the contrary, the vast majority of market commentary seems focused on the 'dip buying opportunity'. As we have pointed out all year long, indicators of sentiment that have proven long term significance, such as the mutual fund cash-to-assets ratio and total margin debt have been in 'red alert' territory for many months. One should thus probably spend more time on pondering what could go wrong than on the alleged dip buying opportunities. However, as you will see further below, we do believe investors should begin to consider the opportunities that may present themselves in European markets over coming weeks.
One of the signs that risk is extremely high is the run-up in CDS on the debt of major European banks. The sovereign debt crisis continues to unrelentingly redound on the fractionally reserved and clearly under-capitalized euro area banks.
http://www.acting-man.com/blog/media/2011/09/eurobankcds1.gif (http://www.acting-man.com/blog/media/2011/09/eurobankcds1.gif)
A simply arithmetic composite chart (unweighted) of CDS on BBVA, Deutsche Bank, SocGen, BNP Paribas, Intesa Sanpaolo, Monte dei Paaschi di Siena, and Unicredito. As can be seen, these CDS prices are way above their 2008/9 crisis highs by now – click for higher resolution.
As we have noted on several occasions, interbank and wholesale funding is increasingly drying up in the euro-area. The ECB is taking over an ever greater share of bank funding as silent bank runs are engulfing banks in the PIIGS nations, with more and more banks seeing questions raised about the counterparty risk they pose. What if the banking system suffers a serious seizure that requires even more forceful, panicked ad-hoc measures by the ECB to keep the system of payments going? Can anyone rule something like that out if e.g. Greece were to actually default? Is this risk adequately discounted? Of course we don't know whether it is or isn't, but we kind of doubt it. Meanwhile, euro basis swaps continue to indicate that stresses in connection with dollar funding in the euro area banking system are worsening.
http://www.acting-man.com/blog/media/2011/09/eurobasisswaps1.gif (http://www.acting-man.com/blog/media/2011/09/eurobasisswaps1.gif)
Three month, one year and five year euro basis swaps. Note the continued deterioration in the shorter term swaps to levels associated with previous iterations of the crisis – click for higher resolution.
In addition to the foregoing we would note that the charts of most stock markets simply look terrible. Germany's DAX index specifically is best described as a horror-show. We have previously warned that the consolidation following the initial weave of heavy selling looks like some sort of running correction. It still looks that way, although no new low has been produced yet, so alternative (and hence more short term bullish) interpretations can not be ruled out yet. Nonetheless, this is an ugly chart no matter which way one slices it. The biggest concern must be the weakness exhibited in the recent bounce attempts and the ease with which very large sell-offs have tended to occur. For instance, Friday's decline doesn't look like much on the chart, but it was actually a quite considerable plunge of 3.4%. ....... there more at link