Europe: Out of Time

So, we’re finally here; at the end of the line for the European Monetary System, and perhaps for the whole union. It’s been quite a ride. But don’t think for a second that it’s all over. In fact, the EU leaders are now forced to make their moves at Thursday’s summit in Brussels. There is no more time for debates, arguing or quarrels. If they fail to agree on some form of debt pooling and a shared fiscal destiny, they risk a full-fledged run on Europe’s bond markets and a disorderly collapse.

“Euro zone politicians don’t – or don’t want to – understand that the euro zone as we know it is on the precipice. Greece appears beyond repair.”

Suki Mann

The EU has a long history of muddling through existential crises, so it may very well find some way to fudge the fiscal union with a formula that assuages German hawks and lawyers. If all else fails, it can still cajole or order the ECB to undertake mass bond purchases and usher in a fiscal union by the back door. But the big  question is: does Germany really want to pay the costs of monetary union any longer?

“What the market is worried about is Germany’s long-term commitment to the euro project. If we see unreserved and absolute backing from the political establishment of Germany, that will be a soothing balm.” says David Bloom, currency chief at HSBC.

Adding: “We are heading towards fiscal union or break-up. Talk is no longer enough as the fire threatens to leap over the firebreak into Spain and Italy.”

Chancellor Angela Merkel seemed in little hurry on Tuesday to convey such a message.

There will be no “spectacular step” at the Justus Lipsius building on Thursday; just a “controlled process of gradual steps and measures“, she said with unflappable calm.

Given the simmering wrath from top to bottom of German society, it may be impossible for her to do much more.

Jens Weidmann, the Bundesbank’s president, has made her task that much harder by telling the eurosceptic Bild Zeitung that “nothing would destroy the incentives for a solid budget policy more quickly and more permanently than joint liability for national debts. European and especially German taxpayers would have to answer for the entire state debt of Greece. That would be a step toward a transfer union.”

Days earlier he shot down proposals for issuance of eurobonds or use of Europe’s rescue fund to buy Spanish and Italian bonds on the open market, crucial steps to prevent Italy and Spain being drawn into the maelstrom.
“It has a high cost, limited use, and dangerous secondary effects,” he says, departing radically from the script of the European Central Bank.

In essence, this is a soul-searching drama within Germany over its own national destiny and place in Europe, echoed in the Netherlands, Finland and even France.

Europe’s confusion reflects the schizophrenia of its ancient tribal nations, each faced with the fateful choice of crossing the Rubicon to an EU Treasury and joint government or letting the EU project unravel after half a century.

Suki Mann from Societe Generale caught the mood in a note to clients, asking whether it is “all over:”

“Euro zone politicians don’t – or don’t want to – understand that the euro zone as we know it is on the precipice. Greece appears beyond repair, Italy is on the brink, and the chances are that the euro might be no more very soon.”

RBS fears that Europe is on the cusp of “system-wide convulsion” after yields on Spanish 10-year bonds reached post-EMU records of 6.34pc this week, and Italian yields topped 6 pct.

“We believe that Spain has entered the danger zone for yield levels,” says Harvender Sian, the bank’s credit strategist, who fears the “point-of-no-return” may be 6.5pc.

“Given that Spain – and likely soon Italy – has entered this territory, there is a growing risk that a large systemic risk event is plausible in the near term and if not then in a matter of weeks.”

The bank has called for a bail-out fund with €2 trillion of full lending power to stabilize the system, even if this risks pushing German debt levels above 110 pct of GDP and causing apoplexy in the Bundestag.

“We are approaching the endgame for this part of the European sovereign crises: the number of cans that now need kicking down the road would challenge the left foot of Lionel Messi,” says Gary Jenkins from Evolution Securities.

“The chances are that the EU will only take the step of fiscal union or common bond issuance at one minute to midnight on a weekend when it is clear that the system is close to collapse.”

MORE from The Telegraph:

Risk-Taking Or Short Covering?

It is debatable whether investors were genuinely adding risk or if participants were merely covering shorts ahead of tomorrow’s EU summit. But what is was actually a very strong day for the credit, Wednesday, according to Markit Financial Information.

The Markit iTraxx Europe index tightened by 6 basis points, to close at 117,75 bp’s, with the vast majority of underlying constituents rallying.

Events across the Atlantic boosted sentiment at the opening.

“Progress seems to have been made in lifting the US debt ceiling after Barack Obama supported the agreement set out by the so-called “Gang of Six, a group of bi-partisan senators,” credit analyst Gavan Nolan writes in his Intraday Alert.

The deal appears to include a mix of spending cuts and tax reform. The latter issue has been the stumbling block thus far, with Republicans refusing to countenance tax rises.

“We will soon find out whether the proposed deal will persuade them to compromise,” Nolan notes.

Tomorrow’s summit has taken on massive importance, a fact underlined by several high-level interventions today.

European Commission president Jose Manuel Barroso called for EU leaders to “show European responsibility” tomorrow and said the summit must provide clarity on the issue of private sector participation.

He said that the “feasibility and limits” of bondholders involvement should be clarified, perhaps suggesting the EC is luke-warm on this issue.

Barroso is also looking for the EU to establish the scope for more flexible action through the EFSF.

“The idea of bond buybacks financed by the EFSF – mooted many months ago but dismissed as unworkable by EU leaders – now appears to be gaining in popularity and will probably be at the forefront of discussions tomorrow,” the Markit analyst points out.

A letter signed by numerous high-profile European economists today – including Paul de Grauwe and Daniel Gros – supports expanding the EFSF to buy back government bonds and also to recapitalize banks.

A levy on banks is also thought to be under consideration, though the reaction of the German and French banking federations today suggests that this will be met with fierce opposition.

“It would be no surprise if participants sat on the sidelines tomorrow morning and waited for the outcome of the summit,” Nolan writes.

“Indeed, there just 50 trades on the Markit iTraxx SovX Western Europe index, well below the average of 149. Greece, the reason why the great and the good are meeting tomorrow, has seen a sharp deterioration in its liquidity recently.”

A paltry $289 million was traded last week, less than 3% of the $12.4 billion traded in Italy, according to DTCC data.

Markit Liquidity Metrics show that the number of quotes has remained low this week and the bid/ask spread is still in the region of 200 bp’s.

Italy was comfortably the highest of any name traded, and the number of contracts that changed hands was unprecedented.

“And that tells the story of why the EU has found a new sense of urgency: contagion cannot be allowed to grip the euro zone’s third-largest economy” Gavan Nolan concludes.

Well, there are, however,  some things that just can’t be regulated by law…

  • Markit iTraxx Europe S15 117.75bp (-6), Markit iTraxx Crossover S15 439.5bp (-21)
  • Markit iTraxx SovX Western Europe S5 281bp (-14)
  • Markit iTraxx Senior Financials S15 175bp (-13)
  • Markit iTraxx Subordinated Financials S15 306bp (-21)
  • Sovereigns – Greece 2300bp (-223), Spain 342bp (-15), Portugal 1085bp (-91), Italy 287bp (-18), Ireland 1055bp (-84)

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13 Comments

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13 responses to “Europe: Out of Time

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