The European markets are now zooming in on Brussels and the crucial top summit, starting tomorrow Thursday 24. Most market participants are not particularly optimistic, in fact, they’re preparing to punish the EU politicians if they don’t deliver on they’re promises.
“It now seems unlikely that there will be a compromise at the summit.”
Gavan Nolan
Credit spreads opened wider this morning as traders woke up to higher oil prices and a Japan nuclear situation that is far from resolved. But the main focus for European markets today, and probably for the rest of the week, is closer to home.
The price of Brent crude broke through $116 barrel in the early hours of this morning and remained above $115 throughout the day, as Colonel Gaddafi made his first speech since the air strikes began and the Libyan leader was defiant as ever, pledging that there will be no surrender to the international coalition.
President Obama announced Wednesday that Gaddafi may try to “hunker down”, raising the prospect of a protracted conflict that will curtail oil supply for an extended period.
But Foreign Secretary Hilary Clinton says, however, that Gaddafi’s camp have been sounding out other countries about a possible exile, making a swift end to his regime a possibility.
The tentative optimism around Japan faded today when workers were forced to evacuate the Fukushima nuclear plant. Smoke was seen coming out of the problematic no. 3 reactor, thereby stopping the repair work that had continued through two aftershocks this morning.
“The indirect effects of the accident are also damaging sentiment. Unsafe levels of iodine have been detected in the Tokyo water supply, and the US has become the first country to ban food imports from the area around Fukushima. Tepco has given back some of its gains from yesterday,” credit analyst Gavan Nolan at Markit writes in his daily Intraday Alert.
Zooming In
But the European markets are now zooming in on Brussels where the important top summit starts Thursday.
There is still plenty of loose ends to tie up; particularly around how the EFSF will reach its full lending capacity and the terms of Ireland’s bailout loans.
We saw Friday with the European bank stress details – no list of the banks involved, capital requirements not defined, no haircuts on sovereign debt held in banking books – how the authorities can disappoint investors.
“Next week’s crucial EU summit has to deliver on its promises if further punishment for the peripherals is to be avoided,” Nolan pointed out in last weeks summary.
Portuguese Trap
Portugal’s minority government faces a crucial vote Wednesday afternoon on its latest austerity programme.
The opposition have already said they will vote against, and if they follow through with their threat then it could trigger a general election.
“This would be an inopportune time for Portugal’s government to collapse, to say the least,” Nolan comments.
Adding: “The two-day EU summit starts tomorrow, and if Portugal’s governance is in disarray then its position will be weakened.”
“Many already expect the Iberian country to have little choice but to accept a bailout before its redemptions in April, and the latest bout of political instability won’t help its cause. Hopes that this summit would yield a “grand bargain” have been fading for some weeks now, and reports emerging today suggest that the pessimism was justified,” the Markit credit analyst writes.
Details of how the EFSF will reach its full EUR440 billion lending capacity will not be agreed at this summit, according to Reuters.
It is probable that domestic politics has had a deal of influence here, according to Nolan
“The government of Finland, one of the AAA-rated euro zone members, has refused to countenance raising its guarantees, no doubt influenced by vocal opposition from right-wing parties at home.”
Angela Merkel’s German government also has domestic considerations that could stay its hand.
Another crucial point that was expected to be resolved this week – Ireland’s bailout terms – could be left hanging. A German official was reported as saying that a deal was unlikely; the situation had not changed since the interim agreement earlier this month.
There is little doubt that Ireland’s 12.5% corporate tax rate is the bone of contention.
“It now seems unlikely that there will be a compromise at the summit. Peripheral spreads widened before recovering later in the afternoon.More volatility can be expected in the days ahead,” Gavan Nolan concludes.
See also:
The EU End Game: Regaining Control
The EU End Game: Decision Time
- Markit iTraxx Europe S15 104bp (+0.5), Markit iTraxx Crossover S15 385bp (+2)
- Markit iTraxx SovX Western Europe S5 174.5bp (0)
- Markit iTraxx Senior Financials S15 149bp (+3), Markit iTraxx Subordinated Financials S15 265.5bp (+7)
- Sovereigns – Greece 970bp (+7), Spain 219bp (+3), Portugal 531bp (+1), Italy 159bp (0), Ireland 610bp (-9)
- Saudi Arabia 127bp (+2), Bahrain 335bp (-7)
- Japan 105bp (+5)
- Tokyo Electric Power Co – 270bp (+30)
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EconoTwist's 
The Risky Are Rallying
Well, why not? The EU leaders are not going to solve anything this time either. That means the central banks have to keep on buying government bonds to keep the prize stable and prevent a total collapse. Seems like a pretty safe bet to me…so far…
“If the EU does opt to muddle – let’s “wait and see” – through then it will no doubt fall on the ECB to provide support.”
Gavan Nolan
Not even the collapse of a euro zone government could prevent risky assets rallying today, with stocks reaching their highest levels for two weeks. As expected, Portugal’s minority Socialist government lost the vote on its latest austerity package, prompting the prime minister Jose Socrates to resign. The incumbent government will continue in a caretaker capacity until the president calls a general election, which will probably be held within the next two months. This complicates matters even more for the EU and Portugal, according to Markit Financial Information.
The latter country’s yields were up around 7.75% (Markit Evaluated Bonds) earlier today, a level that is clearly unsustainable over the medium-term.
Pressure was already mounting on Portugal to accept a bailout, and this will only increase over the coming days and weeks. But the power vacuum makes a rescue problematic.
“If the country is to receive loans from the EFSF it will need to agree to another round of austerity measures. The caretaker government doesn’t have the mandate to do this. Portugal might have to wait until the new government is elected in May,” credit analyst Gavn Nolan writes in the Intraday Alert from Markit.
But it faces a large bond redemption in April:
“Investors will be looking at a country that is politically unstable with low growth prospects; high yields will be required to stimulate demand for the debt. If the EU does opt to muddle – let’s “wait and see” – through then it will no doubt fall on the ECB to provide support.”
There were rumours today that the central banks was active in buying bonds. Hovever, some traders said there was no substance to this.
“The sanguine view taken by the markets – the sovereign’s CDS spreads ended the day flat – implies that a bailout is all but inevitable. A rumour that a rescue was impending helped spreads recover from earlier widening. The markets will be looking for at least a message from the EU summit that the EFSF is available to Portugal,” Nolan underlines.
Investors have become prepared for disappointment from the summit.
“This isn’t an unfamiliar feeling for the markets where EU gatherings are concerned. It is not even certain that the debt crisis will be the main topic of discussion; Libya and the fate of nuclear power could occupy much of their time.”
Two of the main concerns of financial markets – the funding of the EFSF and Ireland’s bailout terms – are highly unlikely to be resolved at this summit.
The first issue is expected to be addressed once domestic political hurdles are overcome in Finland and Germany.
“But the latter issue will probably be more challenging. Ireland’s intransigence on its corporate tax rate is clearly bothering some of the other members, but the elephant in the room is the recapitalisation costs of the Irish banking sector,” Gavan Nolan points out.
Adding: “If a figure in excess of EUR35 billion is revealed in the stress tests results at the end of this month, then the country’s solvency will come under intense scrutiny. Burden sharing by senior bank bondholders – anathema to the EU’s powerbrokers – will be back on the agenda.”
The great and the good at the EU will take some comfort from the absence of contagion in the sovereign credit markets.
Spain’s spreads would have been widening sharply a few months ago if Portugal was under similar pressure as it is today.
“But the larger Iberian country is no longer seen as a credible candidate for a bailout by most market participants, evident in the difference between the two sovereigns’ spreads, now at a record high,” Nolan concludes.
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