The T Report: Spain, Greece, Spain, Greece, Spain
Spain
Freefall. The Spanish 2 year bond is almost at 6.5%. It got as high as 102 in price terms during the height of the LTRO feeding frenzy. It is now at 95. Those are the sorts of moves that signal extreme danger. No one is will to buy short dated bonds aggressively.
The Spanish Bank bailout remains to be seen. There was supposed to have been up to €30 billion made available in July, but I certainly haven’t seen any details.
The ESM approval has been delayed, and the EFSF hasn’t done anything. No bond purchases, no funding of banks.
Europe is moving too slow and the options are getting more limited by the day. The failure to see that acting early and aggressively is far more efficient than waiting until the rot has set in is depressing. Maybe it is because they are politicians or because they are economists, that once again the failure to act and follow through is hurting the markets. Even if they do act, it won’t have the same impact.
That is the real problem. They will almost certainly say things to calm the market, they might even do a couple of things to calm the market, but credibility has been shot.
Greece
The fiasco that is Greece continues. The ECB won’t accept Greek bonds as collateral but is comfortable owning Greek bonds at cost. That needs some serious thought. Something that is so risky that you won’t let someone use as collateral is safe enough to own close to €50 billion of and expect to get paid par. The ECB held debt is the most expensive in terms of coupon, and it has the shortest maturity.
Greece also owes the IMF, who also doesn’t want to make payments.
The ECB and IMF seem to have decided to believe their hype. They have fallen for the trap that they are “bailing out Greece” when in reality, most of the money goes to bail out the ECB.
Germany in particular seems to be confused by where the money is going.
This is also a country that was supposed to do a bank recap back in March. The delays in bank recapitalization are obvious to everyone, except it seems, for the EU leaders.
“Uncertainty”
If you assume away rational thought, human nature, and fear, then an exit by Greece or Spain can be handled without “too much” fuss. In the real world, the confusion will be immense. American companies will be scared to death of doing in business in Europe until there is “certainty” over the structure. I see trade grinding to a halt and the global economy experiencing a “lehman” moment.
The uncertainty and confusion over what a Europe breakup would look like, coupled by defaults in Greece and Spain would make anything prior to that look like a stroll in the park.
At the same time the ECB will take massive losses. The EFSF will have big losses. The IMF will have to fight with countries to get paid.
This was all preventable. We may even see another round of announcements trying to prevent it, but more and more it looks like Europe truly doesn’t get it, and is set on a path of maximum economic pain, without even realizing it.
Thin Markets
Markets are “thin” and illiquid. That is making the move worse than it might otherwise be, and the ensuing rally may also be strong, but it is getting extremely hard now to believe Europe is really going to deliver. They had their chance. They seemed to be making some progress, but suddenly they are once again acting as though parties won’t act in their own best interest.
Germany in particular seems to think it is playing a game of chess where it gets to move 3 times for every move the other player gets and that it can tell that player what move to make. As the relationships grow more antagonistic, that scenario is unlikely to happen. Countries will go out of their way to make things painful for Germany and the ECB.
It may not be too late to stop the death spiral, but the actions of the past two weeks (or lack of action) have certainly put us back on that path, and expecting “decoupling” to save the U.S. markets is foolish.
So far the markets have barely punished Germany, let along the U.S., which should be taken as a gift. An opportunity to get out before everyone realizes decoupling is not a realistic option.
LIBOR
Who cares? It is definitely shifting to the backburner, along with earnings as the focus goes back to more immediate problems. Both earnings and LIBOR will have their impact on the market, but in a world where Europe looks on the verge of collapse and contagion, they matter far less.
Positioning
Getting out of more remaining risk as stayed too long and got greedy. I should have shorted last Thursday when I was tempted repeatedly.
We may get a relief rally, in which case Spanish and Italian assets should benefit the most. Banks too could do well.
Germany and the U.S. seem in complete denial, and with the S&P still at high levels, and vol still near the lows, buying S&P puts seems like the cheapest way to play the move. Frankly it seems unbelievable that you can buy August 1,325 puts for about 10. These were at almost 25 on July 12th. Yes, time decay plays a part, but the move up in stocks and down in vol makes U.S. market puts attractive, as we should get dragged down by continued problems in Europe and I don’t expect the campaign rhetoric here will help investors get comfortable that the U.S. can solve its own problems.
High yield bonds still seem okay. You can probably sell some to raise money to buy at better levels, but I wouldn’t expect a big sell-off in this market yet.
Headline Watching
I am looking for a “bounce” headline, but unfortunately so is the rest of the world. The move in stocks away from Spain and Italy seem to calm. We are all waiting for something out of Europe. We will continue to slide until we see something, but I would expect any rally to be very short lived unless they come up with something big, real, and IMMMEDIATE.