A strong post-summit rally, but caution already returns
We have noted for some time that one of the surest ways to make money in the financial markets is to bet on a brief downturn ahead of a summit, a strong rally immediately afterwards, to be followed by a downturn again once investors understand the full implications of what has been decided. Yesterday, we were in the middle of stage two of this process with a big rally in equity markets, a rise in the euro to back over $1.41, and a fall in spreads. French spreads are now back below 1%, though Italian spreads remain too high for comfort at close to 3.7%. After the summit, the urgent focus among policymakers is to persuade foreign investors to take part in the eurozone’s CDO. Gavyn Davies noticed yesterday in a comment in the FT that that the increase in the EFSF’s firepower has yet to happen. They still need to bring in outside capital. The FT writes this morning that China will probably contribute to the fund, but is seeking further assurances about the safety of its investments. The paper quoted the Chinese economist Li Daokui, a member of the People’s Bank’s monetary policy committee, as saying: “It is in China’s long-term and intrinsic interest to help Europe because they are our biggest trading partner but the chief concern of the Chinese government is how to explain this decision to our own people… The last thing China wants is to throw away the country’s wealth and be seen as just a source of dumb money.” Klaus Regling is in China this morning, trying to sell his CDO. He said that he was in contact with sovereign wealth funds around the world, and expected China to take part, given that the country had a “particular need to invest surpluses”, according to Reuters. But he also said he expected no conclusive agreement during his visit. (The comment by Professor Li highlights the fundamental difficulty of the eurozone CDO from the perspective of sovereign wealth funds. The whole idea behind the levered EFSF is to limit the losses for member states, by bringing in outside capital. The member states have not increased their equity stake. They only provide a first-loss insurance. China will ultimately require some backstop guarantee beyond of what is on offer, either from the ECB or a joint and several guarantee, before poring large sums of money into such a structure.)
Italy is expect to pay 6% at 10-year auction Reuters reports that Italy is likely to pay a record yield of around 6% at its 10-year debt auction today, despite yesterday’s market rally. It will be the first post-summit debt auction, and is seen as an important market test. The reports cites an Italian fixed income analyst as saying that the market reaction was unlikely to extend much beyond yesterday’s rally. Investors were now more interested in the implementation of decisions, especially in the case of Italy.
Merkel’s triumph? The post-summit news coverage of Bild was characteristic of the German media comment yesterday. After briefly celebrating Merkel’s victory, their headline this morning was more sobering: “How much does it cost? Who is going to pay? Who expensive is it going to be for me?”(Not a single question was answered, of course.) Spiegel Online also leads this morning with a post-summit analysis, which highlights the risk of this deal to the taxpayer, looking at various catastrophic default scenarios.
Greece should not have entered the eurozone In a one-hour televised interview Nicolas Sarkozy admitted that it had been an error to admit Greece to the eurozone in 2001. “It was an error because Greece entered with false figures… it was not ready” he said. In this interview he also officially recognised that economic growth in France is revised downwards to 1% and that this requires an additional savings programme of €6bn to €8bn. Le Monde has a good overview of the main points in this interview, an exercise to show his fighting spirits and profile himself against Francois Hollande.
ISDA says No Default (for now) This is potentially a misleading story. Newspapers report this morning that the “voluntary” PSI increase to 50%, agreed by the IIF, would not qualify as a credit event. The head of ISDA’s legal department is quoted as saying that there will be no payments if the agreement is voluntary. (That statement, however, is a tautology. Of course, if they can organise a voluntary participation that succeeds in raising the €100bn, then there will be no CDS trigger. But once they force investors to take a loss, CDS will be triggered immediately. The question is therefore, will this agreement remain voluntary right to the end?) An estimate by the Depository Trust & Clearing Corporation suggests that the net outstanding amount of CDS on Greek papers, is relatively small – at €3.7bn. FT Alphaville has all the details about how large gross exposures can turn into small net exposures.
Olli Rehn becomes vice-president of the European Commission He has had a relatively good crisis. Olli Rehn has now been promoted to the job of a vice president of the European Commission, Il Sole 24 ore writes, with special responsibilities for “monetary affairs and the euro.” The paper says in its headline that this makes him effectively Mr Euro. Rehn announced yesterday that on November 23 he will propose his green paper on Eurobonds, which he euphemistially calls stability bonds.
Mark Schieritz on why this agreement is not going to work Writing in his blog Herdentrieb, Mark Schieritzh says the summit’s agreement is not going to work for three reasons. Investors will come to regard the EFSF as offering too little insurance (the Chinese reaction yesterday suggests that this is already happening). The bank recapitalisation is bad for the economy. And the Greek debt default will lead to expectations among market participants that the same will happen in other peripheral countries. To this effect, he cites a report showing that Commerzbank is considering selling the lion share of its peripheral debt portfolio.
Wolfgang Münchau on why this agreement is not to going work Writing in the FT, Wolfgang Münchau says the two most important aspects of the deal are unlikely to succeed without further changes. He notes that the strategy to reduce the Greek debt burden is likely to fail on three grounds. First, it is not clear at this stage, how the IIF is going to organise a voluntary 50% debt reduction. The large member banks can be “voluntarily” coerced, but many investors will not participate. Second, the projections that this haircut would stabilise Greek debt-to-GDP at 120% are too optimistic. And third, he says that Greece will need a much lower debt level than 120% anyways to be able to return to the markets. On the EFSF, Münchau says that leverage will ultimately require an explicit lender-of-last-resort status of the ECB, a joint and several guarantee, or both.
Martin Winter on the new Europe Writing in Sueddeutsche Zeitung, Martin Winter says it is not clear yet whether the financial instruments created at the summit would suffice, but Europe had already succeed to regain the world’s lost confidence. But he said the Europe that has emerged from this crisis is different. The south will be weaker – its sovereignty clipped by financial constraints and political interference from the north. The relative importance of France will be diminished, and that of Germany increased. This is not a role that Germany wanted – and one that it has traditionally avoided. This is a big responsibility for Germany.
Günther Nonnenmacher about’s Europe’s fledgling fiscal union Writing in Frankfurter Allgemeine Zeitung, Günther Nonnenmacher argues that the gigantic sums committed to the eurozone rescue effectively amount to the beginning of a fiscal union of eurozone member states, and that this would now definitely bring about a two-speed Europe, a fiscal union at its core, and a lagging non-eurozone periphery. He concludes that the reforms that have currently been undertaken will come to be considered as the most far-reaching in the EU’s history.
Spreads, Forex, and ZC Bonds Better across the board. French spreads in particular fall below 1%. But notice the still extremely high spread of Italy.
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