View: Periphery debt tempting, short Bunds great risk reward at current levels
Gloom continues to dominate Eurozone investor’s thinking with the market reluctant to buy into the idea that there are now adequate backstops (ESM, OMT) available to finally stabilise the debt crisis, continuing to focus on the always distracting political noise. This seemingly forgets as to just how the Eurozone crisis has developed over the past three years or so, specifically just how long it takes for the numerous political factions forging those numerous ‘breakthrough’ agreements to find a consensus on the critical final details. Furthermore one can see from previous bailouts that the longer one generally stalls the easier conditions imposed eventually are, making foot dragging an essential component. Of course the Greek problem remains but even there there seems to be a realisation among the core that it is better to keep the patient’s heart beating than force the country out; at least immediately – which means this side of next year’s German federal elections. In fact senior politicians from both sides have been clear about this over the past couple of weeks.
Full report below…
View: Spain ‘worries’ totally predictable, PM Rajoy’s delaying tactics all part of the game
Watching the Eurozone crisis unfold is a bit like sitting down to watch a few Road Runner cartoons, we all know Wylie Coyote is going to run over a cliff at some point we just don’t know what sort of pain and suffering he’ll go through first and the particular shape he’ll form when he hits the bottom. In these terms one could well compare the market to a four year old, deriving endless surprise, dare we say enjoyment, from what is a tried and tested formula. And so we find ourselves with panicked headlines from Spain once again with the usual media tarts rolled out with a new damning indictment on why the project is doomed, a scenario as predictable as any of those classic cartoons.
Full report below…
View: Bears should have much better levels to play from, 1.63% the key level for Bunds
Quite how far this risk on move can go is hard to say, much of the detail of the Draghi plan was leaked ahead of time but still there was a rush of new money into risk assets once the OMT was formally unveiled and this morning’s German constitutional court decision was equally unsurprising in its outcome, even the oversight the Court requested with regard to the level of German contributions to the ESM.
Full report below…
View: OMT helpful, but not unexpected. Should temper Fed doves demands for easing
While the crux of what the ECB was working on was well flagged in advance of Thursday’s policy meeting thanks to the usual ‘official’ leaks there seems to have been enough doubters to trigger a very positive market response to the official unveiling of its new bond purchasing plan. It is perhaps partly down to timing; we didn’t actually expect such explicit detail until the German Constitutional Court had dealt with the ESM issue and the fact that there was not any immediate pressure to finalise a strategy thanks to effective verbal support over the summer was another reason to pursue things in the usual Eurozone timeframe, i.e slowly. Furthermore the hostility of the Bundesbank to debt monetisation, as they see it, was (and still is) problematic. It appears Draghi just accepted that this wasn’t something that could be resolved with Weidmann clearly the sole dissenter when the board came round to voting. Another factor might be worth mentioning is the proximity to the FOMC meeting from which the market also expects support, admittedly aimed at addressing growth rather than solvency/survival of the Euro. We’d normally have expected some buck passing to the more proactive Fed, although in this instance the opposite might be true, more on that later.
Full report below…
View: EUR/USD1.1877 the key draw, discipline is to keep selling rallies
Euro price action has been a little flat over the past few days, failing to find momentum following the breach of the 1.2288 support level last week which marked the low point of early June. This has been despite generally negative news flow out of the region too, specifically the issues surrounding the Spanish bank bailout which is covered off rather well here (http://bit.ly/Ngd8Zq) and new round of self-defeating austerity announced by PM Rajoy this morning. This looks a little unusual in our eyes given that these developments create more questions than answers in terms of the banking bailout and further budget cuts/tax increase are likely to only deepen the Spanish recession and we know where that spiral goes. Furthermore there remain doubts about the ESM, currently caught up in the German Constitutional Court among other places, and the ECB’s tone continues to be standoffish, suggesting the crisis will continue to run with obviously negative implications for the EUR.
Full report below…
View: Banking/Fiscal union something for a smaller Eurozone, we dislike French debt
Global markets response to the Spanish bank bailout is interesting, it appears that investors have become a little more confident they can compartmentalise the situation while at the same time seeing the package as insufficient, which is most clearly visible in the diverging paths of equity markets and Spanish bonds. The poor performance of this market is clearly understandable given the structure of the package will be detrimental to existing SPGB holders, effectively creating a €100bn tier of debt that sits above them on the creditors list (assuming it is channelled through the ESM), something we know from Greece is never good. Furthermore the actual sums involved look unlikely to be sufficient, even the Spanish government acknowledges that there are still significant downside risks in the property market. New guestimates from JP Morgan have suggested the sector might need €350bn in total, ouch. It doesn’t look particularly good for some of the other creditors, Italy for example will have to fund its contribution in the markets at 6% while lending to Spain at 3%.
Full report below…
The simple answer is some sort of systemic collapse of peripheral debt markets (including Italy and Spain) which doesn’t seem to be too far away given recent price action. Liquidity is virtually non-existent even before accounting for the usual thinning of markets during the summer and while EU officials seem to be aware that markets are troubled they still look committed to the line that recent developments in Spain and Italy are “clearly unwarranted” to quote EU Commission President Barroso, despite the oxymoronic admission of the “systematic nature of the crisis”. The fact that this flare up comes so soon after July’s summit, designed to put a stop to contagion once and for all, underlines the feebleness of EU institutions. No sooner had that meeting finished core Europe was stating that the Greek package was a “one off”, apparently oblivious to the fact that the rest of the PIIGS continue to float on the edge of the same abyss.
It is clear the Germans can’t square stumping up more cash with their electorate but at the same time they are unwilling to support any meaningful debt restructuring, fearful of what this might do to the local baking sector no doubt. Indeed, estimated private sector participation in the Greek package indicated haircuts of no more than 20% when 10-year bonds were trading at rates pointing to a 50% recovery rate. 2-year yields never fell below 25% and are now back at 30%+.
The winner in all this has been bunds, undoubtedly the safest European asset in the face of this turmoil and thanks to debate over the US’s AAA status perhaps the ultimate safe haven asset globally now. But it’s not just a flight to quality bid that underpins. Germany’s earlier robust export driven recovery also looks to be playing a part now, impacted by on-going weakness in club-Med, the aftermath of the Japanese earthquake and growth pressures in the US exacerbated by the recent debt ceiling clash. Add on Chinese efforts to cool inflation, Indian overheating and a fairly soft Brazil and the risks multiply for the export driven model.
Technicals have been working very effectively for bunds against this backdrop, while the EU summit triggered a shift to neutral mid-month, the run back through firstly 128.19/21 and then 129.36 both gave fresh signals to buy. Today’s reversal from the Oct ’10 highs shouldn’t prove to be a significant reversal point when looking back in a month or two’s time. There is room for a dip back into the mid 129.00’s intra-day perhaps but this won’t change the objective, a retest of the April ’10 top at 134.73/77 which in cash terms implies a yield of around 2.10%. To print sub 2.00% is the real draw for the cash market, we’d bet this comes before the Eurozone end-game too. Against this backdrop we maintain our preference for short EUR/USD too, though prefer EUR/JPY, JPY to remain a beneficiary of any prolonged risk unwind.
- EU Barroso, Zapatero Urge EMU To Speed Up Crisis Response (forexlive.com)
- Europe’s money markets freeze as crisis escalates in Italy and Spain (telegraph.co.uk)
Demand for bunds may have eased off as Italian and Spanish bond yields steadied after Monday/Tuesday’s wobbles (to put it mildly) but technically the pullback we’ve seen so far doesn’t hint at a sustained reversal in that flight to quality bid. To prompt a more sustained unwinding we’d need to see the futures market (RX1) crash through support in the 127.32/57 area in the first instance and given the underlying bull trend that we first picked up on mid-June, accumulating on any dip into this zone should continue to be the longs game, aiming for an eventual push through Tuesday’s 130.91 intra-day high. A run through 129.31/36 would see bullish momentum pick up again (note H&S proj target from the Apr base came in at 129.43).
The trigger issue remains the periphery of course and to date flare ups in risk perceptions have been interspersed with periods of more stable trading which might suggest some normality in the coming period. But with Italy now being drawn into the peripheral club the crisis has taken another serious turn and one that is likely to lead to more volatility. We believe that eventually the politicians will get a proper grip on the problem but recent rhetoric hasn’t been particularly encouraging – behind closed doors we believe divisions on how to resolve the debt issue are plentiful -meaning it will be left to markets to force the issue. You can’t get more bullish driver of bunds than that.
- A dark day for Europe (businessinsider.com)
- Tuesday’s ETF to Watch: DB German Bund Futures ETN (fool.com)
Hopes that there might be some consensus evolving on Greek debt appears to have evaporated with European bond yields seeing savage moves on Monday. Bunds fell up to 20bps as investors sought out save haven assets. At the same time Spanish 10-year yields hit a post crisis high of 6.00% (up 35bps on the day) and Italian bonds – which have proved less sensitive to such stories throughout much of the crisis – were slammed 42bps higher to end the day around 5.68%.
The recent performance of BTP’s is worrying on numerous levels. Italy is obviously critical to the EUR project, its economy being around 45% larger than Spain. We don’t think Italian solvency is the ‘killer’ issue; if we got as far as that it probably means Greece, Portugal, Ireland and more notably Spain have already gone. What it does is weaken the German driven austerity solution and instead increase pressure to create a swift and effective mechanism (to default) to deal with the debt problem permanently – hence cracks in the French driven plan to voluntarily roll over Greek debt.
Extreme volatility looks set to remain the order of the day for the European bond markets (keep an eye on those ratings agencies, desperate not to be behind the curve on this one!), the euro should also face further heat. Indeed the range break in EUR/USD today leaves the 200-DMA @ 1.3900 exposed; through here the next stop would be 1.3650/60. Bears should feel comfortable as long as we stay sub 1.4220/50. As we noted on July 5th EUR/JPY looks as good a way of playing this theme. Throughout much of the last 12-months the yen has been as much a beneficiary during broader risk off moves, and with the EUR in the firing line this time it looks well placed to continue to outperform. Like EUR/USD we also saw a EUR/JPY range break today, the initial objective of which should be a drive towards 110.56 or close to seven big figures below where we were on the 5th. We have also seen sell signals generated from some of the longer-term moving averages. There is some scope for a short-term bounce but 113.42/60 should provide a solid ceiling from here.
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