European Risk Monitor: Debt’s Drag

Position in Europe: Long British Pound (FXB)

As is typical for Mondays, we release our weekly European Risk Monitor. With European markets closed today for Easter holiday, the theme for this week may be wait and watch. Greek risk continues to blow out (see sovereign cds and bank swap charts below) as the contagion threat from peripheral debt continues to drag.  A bailout of Portugal (~ €50-90 Billion) is estimated for mid-May and this weekend’s news flow suggests that despite the massive gain of the euro skeptic/anti-bailout True Finns party in Finland last week, the new government is likely to agree to a bailout in Portugal.

Finnish Finance Minister Jyrki Katainen, who is set to lead the new government, said that there would be a united voice from Finland on its bailout stance and that he personally was in favor of a bailout for Portugal. Interesting, the European Commission’s top economic official, Olli Rehn, is a Finn, so we could see his Brussels influence should disunion on the bailout issue present itself in the coming weeks. In any case, the statements should calm some market fears.

Greece continues to flash a negative divergence among the PIIGS.  The Greek 10YR yield is at a new all-time high of 14.90% as is its sovereign cds at 1442bps, or +84bps day-over-day (see chart directly below). Our European Financials CDS Monitor shows that bank swaps in Europe were mostly wider week-over-week, widening for 25 of the 39 reference entities and tightening for 14 (chart below).

European Risk Monitor: Debt’s Drag - a. sov cds

The EUR-USD also remains strong.  Our immediate term TRADE range is $1.44 - $1.46 and we continue to caution on the headline risk associated with this trade. We stress that the Euro’s advance has come primarily to USD weakness. The US Dollar Index is down for 13 out of the last 17 weeks, and has lost -8.6% of its intermediate-term value in the last 4 months. However, with the EUR-USD bumping up against our resistance level, and the ever present threat of sovereign debt contagion, this is a trade to monitor acutely. 

We remain long the British Pound via the etf FXB in the Hedgeye Virtual Portfolio and bullish on the impact of UK austerity on the currency. The GBP-USD is at $1.65 this morning, up +1.1% week-over-week or +5.8% year-to-date.

Matthew Hedrick

Analyst

European Risk Monitor: Debt’s Drag - bank swaps