Sunday, November 27, 2011

Things to watch out for this week.

Ludicrous as it may seem the possibility of a Eurozone break-up has risen sharply. Italian yields at 8% and Spanish yields at levels not far behind are quite simply unsustainable. The good news this Sunday evening is that at last the ruling elites in both Berlin and Paris seem to have woken up to how close to chaos we are.

The story going the rounds tonight is that after a series of intra-government meeting overs the weekend President Sarkozy will give a major speech ahead of the next EU summit on December 9th in which he will spell out direct and readily implementable steps to save the €. This will involve support for southern tier bond markets ( overdue ), access to a €580 bn IMF standby line and accelerated fiscal union within the 17.

The markets between now and December 9th can be expected to be turbulent with widespread selling of euro area assets by Asian and North American institutions . The new Belgian government ( also overdue ) is expected to announce a package of cuts totalling €15 bn by the end of next week while pressure is being exerted on Italys PM, Mario Monti , to start spelling out what steps he plans to take. A €20 bn austerity package is the minimum required from Italy.

A Franco-British summit on Friday will pave the way for treaty changes to allow the 17 Euro zone members to forge head .France can be expected to give ground on the proposed Tobin finacial transactions tax in return for promises that Britain will not be obstructive to the treaty changes required for fiscal union and the de facto development of a new inner tier .

Intraday volatility over the next two weeks may be extreme . Are this weekends signals rumour or reality ? If action doesn't follow along by the time of the EU summit then the markets reaction is likely to be brutal. The soluble is close to becoming insoluble .

Tuesday, November 15, 2011

Happy Thanksgving .

Considering what's happening in bond markets equities are holding up pretty well. Down just 2.8% since Fridays close . In the debt markets things are grimmer - spreads have widened and Italys north of 7% again, Spain at 6.32% and France at a € era premium over German bunds . The belief is that the ECB isn't going to press the button on unsterilized intervention - the big bazooka or silver bullet - until we're at one minute to midnight . We're not there yet .

Anyone hoping that this will all be resolved by Thanksgiving will be disappointed . Christmas ditto .

Friday, November 11, 2011

Framany .

A long, grinding, period of low or zero growth beckons - probably through to 2016. It should have been so easy. Recapitalize the banks, provide the ECB with a trillion € 'silver bullet ' and wait for the storm to pass by. It was not to be . Europes institutions were unable to act in a timely and decisive manner. Instead this crisis will rumble on for the next year while the politicians look for a solution .

Venal and incompetent. Two words that best describe Europes current crop of political leaders . Sarkozy and Merkels giggling press conference treatment of Berlusconi ( no matter what you think of him as an individual ) a shameful and immature way to treat another head of state. Scoundrel turned into scapegoat .After the non-event of the G-20 summit it can be seen that financial discipline has now begun to dissolve . The inability to resolve the Greek problem has caused the contagion to spread and the size of the problem to snowball. Plans call for Greece to grow at 2% p.a. to service it's debt but the country is actually shrinking at a rate of 5.9% annually .Iran is now its major supplier of oil .Next it's Italy's turn to be in the bond market spotlight. Soon it will be France. Spain , despite creditable attempts to reform , remains fragile. Spanish growth his disappeared in the latest quarter .Markets are hoping ( and on Friday surging ) that the possible confirmation of Mario Monti as Italian PM might yet enable order to be restored and provide time for the ECB to intervene decisively . President Napolitano a beacon of stability in this turbulent world..

For too long the € enabled credit to be mispriced . Germany and the Netherlands provided financing at artificially low interest rates to poorer southern European governments, corporates and individuals. The consequence of this has been massive debt and overspending in the ClubMed states , including France . A Greek, Portugese and Irish default becomes more probable with each passing day. Merkel and Sarkozy have publicly allowed that countries might leave the Euro. They are now discussing ring fencing the core - France and Germany - Framany - from contamination . What the Italians and Spanish will think of this remains to be seen. Britain as ever remains willing to criticize while offering nothing positive. No wonder the 26 other members of the EU sigh at Londons behaviour. It is however clear that the British electorate will never stomach the ' compulsion ' that is being imposed on the Greeks, Italians, Portugese and French . What happens to the Uk and the 50% of its output that goes to the continent if it decides to quit the EU ? What happens to Greek olive farmer subsidies if / when the UK, the Eu's #2 net contributor, leaves ?

The consequences fo all this ? After a decade of huge, seemingly interest free loans , the party is over. A wave of corporate, sovereign and personal defaults will eventually follow . A recession in Euroland is now probable in 2012 . France is asking the ECB to intervene more aggressively in bond markets but the stark reality of the numbers say that many countries are at the extreme limits of what they can pay . Unemployment is rising across the EU, export orders are falling and consumer confidence has evaporated . The UK mortgage market has effectively frozen up . Metro Bank extended only 100 mortgages in the last 15 months !

Three things stand out :

1) History teaches that after financial crises , credit growth remains feeble for years. Businesses that depend on credit, banks , consumer credit houses and property developers, suffer .
2) Emerging markets owe €3 trillion to EU banks. Much of this will not be rolled over. Asia and LatAm will slow down as the funds are repatriated in order to safeguard the core Euro area and the Euro .
3) Corporate forecasts for 2012 are blatantly optimistic. Bank balance sheets are contracting at an unprecedented post-1945 rate so working capital will be in ever shorter supply . In the US banks have written off only a quarter of the $326 billion of 2007 era subprime property losses. More deleveraging is to come .

History will note that we were so close to avoiding this downturn . It's not Armageddon but this half decade of zero growth will be a painful period fro Europe. The good news is that by 2015 90% of golobal growth will be outside the EU. Great news for the US, Australia and others. . For Europeans though ' a lost decade ' is as good a description as any of what's in store for them as they battle to save a functioning common currency .

In this environment investable corporate debt and high yielding, under leveraged, blue chips seem as good a place as any to be. Markets are buoyant in the expectiation that the ECB will prime the pumps with a € 2 trillion backstop announcment . If so , and the Bundestag will have to give its approval , Germany will have to pay . Then it's time to buy gold on inflation fears. The Euro will survive this crisis , the Eurozone and the EU as we know it won't .