Positions in Europe: Long Germany (EWG); Short Spain (EWP)
The long-awaited date of this Thursday’s Greek vote on austerity is now close upon us after what seems like 2 weeks of intense breath holding on the state of Greece. Late Tuesday of last week PM Papandreou’s government won the confidence vote in a 155-143 decision with every member of his PASOK party voting the party line.
Thursday’s vote on the newest austerity package, which includes €28 Billion of spending cuts and tax hikes and €50 billion of private assets sales through 2015, is essential for its passage is conditional on 1.) Greece’s next €12 Billion funding tranche from the IMF (of the original €110 billion bailout passed in May 2010) to meet maturing debt obligations beginning in July, and 2.) setting into motion Troika’s (EU, IMF, ECB) position on an additional bailout package for Greece (estimated between €70-120 Billion) and steps to “softly” restructure Greek debt, namely by extending debt maturities.
Over the weekend France floated the idea of French banks reinvesting 70% of their maturing debt Greek bonds, with 50% allocated to new Greek debt with a maturity of 30 years (instead of 5) and another 20% directed to a zero coupon fund of “high quality securities”. Clearly there are numerous unknowns surrounding this proposal, including if German banks would follow suit. But importantly, given that France and Germany have the most exposure to Greece of any Eurozone country, with €56.7 Billion and €33.9 Billion of bank and government debt liabilities, they’ll be the leaders in crafting a near to intermediate band-aid to uphold Greek funding needs.
While we’d expect to see more foot power in protest against austerity into and out of the vote on Thursday, ultimately we expect the measure to pass for it’s A.) in the interest of Troika to keep Greece on a short leash to quell talk of default/restructuring (and prevent any contagion weakness to the common currency), and B.) Greece may be able to reach a deal that broadly agrees with Troika’s deficit reduction demands, while specific terms like tax hikes and spending cuts could be back loaded towards 2014/15.
While this is only a hypothetical, such a tactic could be used to appease both Troika and the Greek populous. Ultimately it bodes poorly for any material change in the budget deficit, but then again given Greece’s poor prospects to grow any revenue with such a deflated growth profile, using smoke and mirrors by either party to reach any form of intermediate support should come as no great surprise.
For now, we continue to turn to our risk monitor indicators in Greece and throughout the periphery. While we’ve seen slight inflections, the TREND line in risk continues decidedly higher for CDS spreads and sovereign bond yields. Greek CDS levels defy previous default indicators, and Portugal and Ireland indicate that their previous bailouts will not solve their sovereign and banking imbalances.
Our European Financials CDS Monitor shows a similar picture, with bank swaps in Europe wider last week, on a week-over-week basis for 35 of the 39 reference entities (only 4 were tighter) with a strong negative divergence from Greek banks.
As Troika continues to socialize the Eurozone, we remain very cautious on the region, including on our long position in Germany (in the Hedgeye Virtual Portfolio via the etf EWG) as fundamentals have deteriorated over recent months. For more, see our post on 6/24 titled “Germany: High Frequency Data Slows. Period.” Additionally, we remain short Spain (EWP) where the data suggests continued headwinds from inflation, austerity, unemployment, and its real estate bubble. Just this morning, El Confidencial reported that Spanish banks may have $50BN in unrecognized problematic real estate loans.
With big brother Troika in periphery’s pocket, we see a EUR-USD trading range of $1.41-$1.45. Stay tuned.