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Posts Tagged ‘Europe’

No Publicity is Bad Publicity? Tell that one to Greece…

June 21st, 2011 Michael McDonough Comments off

While it’s often said no publicity is bad publicity Greece is a clear exception to the rule.  Mentions of Greece in stories on the terminal are approaching its May 2010 high; corresponding with the period Greece first accepted an EU sponsored bailout.  Greece’s more frequent mentions has come at a cost for the country and investors alike as bond yields soar, while the price of protecting against a Greek default through CDS rises precipitously.

Greece’s ten year yield is presently trading just shy of 17 percent, highlighting that investors have likely already accepted the inevitable that the country cannot survive without bond holders taking a significant haircut.  The cost of protecting against a Greek default is approaching 2000 basis points, making it more than three times as risky as Argentina on a five year CDS basis.

Greece will be holding a critical confidence vote tonight for Prime Minister George Papandreou that will likely determine whether the country will be forced to default/restructure now or in several months’ time.  After this vote Greece will have two weeks to pass additional austerity measures to unlock an additional EUR12bn in aid from its neighbors—Greece owes approximately EUR18bn in debt payments now through August.  In any case, any European aid will likely prove to be a temporary relief with this scenario playing out again and again until a painful restructuring is finally undertaken.

Hesitation from Eurozone officials around a Greek restructuring are being stoked by the possible impact on their own countries.  Officials are likely trying to buy time in hopes of finding calmer markets before forcing Greece to restructure limiting the potential contagion effect.  The problem is markets can’t calm, while there is still a hurricane raging in Greece.

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Germany vs. France Not Just Being Played on the Pitch

June 17th, 2010 Michael McDonough Comments off

The spread between France’s and Germany’s 10y Government bonds remain near levels not seen since the collapse of Lehman as France takes on tough fiscal tightening.  Since the onset of the European debt crisis France and German yields have benefitted from worried investors moving funds away from economically weak Eurozone peripheries to the regions ’stable’ AAA rated credits.  However, after being blindsided by Europe’s debt crisis investors are developing a new sense of risk, which doesn’t bode well for France’s lackluster history of correcting past deficits, especially while its current budget deficit approaching 8% of GDP.    This has given Germany an edge in investors’ flight to quality. France has already undertaken remedial measures to rein in the deficit, including raising the retirement age to 62 from 60, prompting  protests from the country’s socialist party and labor unions.  France will likely struggle with its ability to rapidly implement the necessary austerity policies, with any significant slippage, or success, revealing itself in the country’s spread to equivalent German government bonds.

Source: Bloomberg

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Risk Makes a Comeback

June 14th, 2010 Michael McDonough Comments off

Investors are feeling more at ease with the uncertainty facing global market.  The AUD/JPY exchange rate—a popular FX carry trade and risk metric—has moved off of its recent lows of less than 74 to a level of 79.4.  At the same time, 3M LIBOR halted its climb, and has remained fairly steady around 0.54%, albeit still more than double early March levels.  Investors growing appetite for risk partially stems from a successful Spanish three year government bond auction last week, which received a surprisingly strong bid to cover of 2.1, while still yielding an elevated 3.3%–compared to less than 2% for bonds of a similar duration in March.  Spain is scheduled to reopen EUR3.5bn of 10Y and 30Y bonds on June 17th.  With a relatively quiet week on the data front—barring the auctions in Spain and a European summit on Thursday—traders will likely continue adding on risk, pushing European spreads down; US Treasury yields up, all boding well for growth correlated assets, including equities.   

Source: Bloomberg

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A Great Video on the Problems in Europe…

May 26th, 2010 Michael McDonough Comments off

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Stocks say Goodbye, & Euro says Hello (to the Crisis)

May 13th, 2010 Michael McDonough Comments off

European equity markets and the Eurozone currency look to be pricing in separate outlooks for the future of the Eurozone after an unprecedented rescue package.  As the chart below highlights, European equities as tracked by the MSCI European index has rebounded sharply from its pre-bailout low–surely aided by the ECB’s recent actions–, while the Euro has gone on to set a new interim low.  Many view the bailout as a temporary fix to a much deeper problem that can only be solved with through harsh continent wide austerity plans—if even then.  If Europe manages to somehow seamlessly enact these cuts, many nations have dug themselves so deep into debt that the slightest hint of a missed number, or even worse a failed debt auction has the potential to derail the entire process; quickly leading investors away from risk.  While the Euro seems to be pricing in this possibility equities do not.  This analysis doesn’t even mention the impact austere policies will have on the European growth outlook, which could also weigh on equities. 

Source: Bloomberg

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Rising TED Spread Says ‘Hold on There’ to EU Bailout

May 11th, 2010 Michael McDonough Comments off

A slipping Euro isn’t the only indicator hinting that Europe’s unprecedented bailout may be insufficient to ease market fears over the developing debt crisis.  3M LIBOR (the intra-bank borrowing rate for USDs) has again begun to tick upward, albeit modestly; halting a retrenchment in the 3M TED spread.  The spread has average 18.8bps over the course of the year, but currently stands at 28.6bps (see chart), well off the year’s low of 10bps.  This could indicate deteriorating credit conditions as confidence within the banking sector diminishes; the TED spread reached a high of around 460bps after the fall of Lehman.  While the market is still far from these levels, movements in the TED Spread and LIBOR should be monitored due implications on future credit conditions and the fact the rate is used to price a number of derivatives and adjustable rate mortgages.  Yet, over the short-term the reopening of the Fed’s swap lines with other central banks around the world could help alleviate this problem as fresh USDs are poured into these markets that the central banks can in turn lend to other banks within their jurisdictions, increasing liquidity.  

Source: Bloomberg

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PIIGS: Europe’s ‘Sub-Prime Borrowers’

May 5th, 2010 Michael McDonough Comments off

As the crisis in Europe continues to spiral out of control, I wanted to take a look at the cost of insuring against default for the PIIGS (Portugal, Italy, Ireland, Greece, and Spain). As you can see from the chart below, over the past several weeks 5Y CDS for the PIIGS has risen substantially, with the biggest gains coming from the epicenter of the crisis—Greece.  Downgrades for both Portugal and Spain with the specter of more to come, have combined with deadly protests in Greece, widening spreads for  the PIIGS government bonds over Germany–the European benchmark rate–to record levels.  I expect volatility will continue as the situation escalates, with Portugal and Italy being most susceptible to increasingly worried investors, and ratings agencies still under significant scrutiny following the US subprime disaster.  Over the short-term, the result of a Spanish 5Y note auction  tomorrow should help measure investor sentiment;  a successful auction could help stymie, at least for the time being, fears of contagion.

5Y USD CDS for the PIIGS

Source: Bloomberg

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Weakness in the Pound Quickly & Simply Explained

March 2nd, 2010 Michael McDonough Comments off

Several weeks ago Fitch warned that out of all Europe’s AAA rated sovereigns the UK was the most vulnerable to lose this rating. But, most analysts believe this would not be an issue as the government would implement austere fiscal policies reigning in large deficits and a growing debt load. Such policies do not come without political backlash, which is why a fear of no majority in the British Parliament is raising concerns that Britain will be unable to enact the necessary policies to stabilize spending. As you can see from the falling pound these risks are now being priced into the market, and trading will likely be volatile until the market receives a clearer picture of the upcoming elections, and whether or not parliament will be able to make these tough decisions without a majority if this does occur. The UK is no stranger to financial strife. In 1976 the UK received a loan from the IMF on the back of concerns over its debt and large budget deficits.

UK Budget Deficit (% of GDP)

Source: Bloomberg

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