Positions in Europe: Covered UK (EWU) today in the Virtual Portfolio
Some things change, some stay the same
Today the SNB announced that it will put a floor under the EUR-CHF at 1.20 and “will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.” The news sent the heavily overvalued currency down -8% versus the EUR day-over-day, after SNB intervention attempts throughout August were largely unsuccessful. We’ve had a bullish bias on the CHF vs EUR and USD for most of the year, yet the tone of the SNB this time around is much firmer—we’d be sellers here.
On the theme of announcements, the head of Slovakia’s junior government, Richard Sulik, said he’d push back the date to vote on the EFSF to December versus the expected late September/early October timeframe. While we’re squarely focused on Germany’s EFSF vote on September 29 due to its leadership in the region—and ability to get the other “ducks” in orders—we’re nevertheless seeing signs that the final votes across countries on the terms of the EFSF will likely be pushed into the October period, versus original calls for mid to late September. As we’ve said before—this indecision will breed more downside risk to European capital markets.
One concurrent issue of note remains Finland’s demands that Greece post collateral on the amount Finland is to contribute to the EFSF. The news here wavers between Finland’s desire for cash (liquid) collateral from Greece for the money it will post to the facility to even talk of Greek bank stocks as collateral, which of course throws up a huge flag given the difference between where securities are marked to market or model. The broader implication remains that what is decided between Greece and Finland will impact similar collateral demands of the other Eurozone countries.
In the category of “some stay the same”, today Italy’s largest trade union is protesting Italy’s €45.5B austerity package in another act of foot-power. This week the Italian senate begins debate on the package, which has been chopped up from the original. The new version removes the Solidarity tax, which placed an additional 5% tax on annual incomes above €90K, and the original proposal to cut €9B in funding to regional and local governments was trimmed by €2B.
Look for indecision with the ECB to arise as the package is trimmed; remember, the ECB’s resumed its SMP bond purchasing program (including buying the secondary issuance of Italian and Spanish bonds) on Italian insurance that it would pass its austerity package to shave its budget, and presumably on the terms of the original package. This development is likely the driving force in Italian yields rising over the past week (more below under Risk Rising).
Risk Rising
Below are charts of 10YR government bond yields and 5YR sovereign cds spreads. Our focus continues to be on Italy and Spain, two countries that present exponentially more sovereign debt risk than their peripheral peers.
Italy’s 10YR yield is up 33bps week-over-week to 5.46%, and Spain’s 10YR rose 14bps to 5.19%. 6% continues to be a critical breakout line. While the ECB has been able to arrest yields in Italy and Spain since it began its bond purchasing program in early August, confidence wanes as Europe fumbles with the terms of the EFSF. 5YR CDS spreads show a similar risk profile: Italy moved up 74bps w/w to 443bps and Spain jumped 52bps to 421bps. Both are well above the 300 line, a critical breakout line.
European Financials CDS Monitor – As opposed to the sovereign direction of Italian and Spanish swaps, bank swaps tightened in Europe last week. 37 of the 39 swaps were tighter and 2 widened. The average tightening was 10%, or 47 bps, and the median tightening was 7%.
Getting in front of the Calendar
(9/7) The German Constitutional Court is expected to deliver a major decision on the constitutionality of Berlin’s participation in the bailouts of Greece, Ireland, and Portugal. We expect the court to rule in favor of the legality of the State’s right to bailout European neighbors. In any case, this will be an important sentiment gauge for the EFSF.
(9/8) ECB Interest Rate Announcement – We don’t expect any movement off of 1.50%. The ECB purchased €13.3B worth of debt last week (vs. €6.7B in week prior), bringing its total purchases since August 8th to €56.25 Billion. Additionally the ECB will be releasing new staff projections for inflation and growth — expect downward revisions!
(9/8) BOE Interest Rate Announcement – We don’t expect any movement off 0.50% but could see a hike to its asset purchasing program, which could weaken the GBP. As sticky stagflation continues to plague the country, our outlook remains bearish over the intermediate term TREND. With the UK immediate-term TRADE oversold today, we booked a gain and covered our position in EWU.
(Mid-September) Troika’s (EU, ECB, IMF) mission to inspect the country’s measures to shave its debt and deficit was suspended until mid-September to allow Greek authorities to complete “technical” work. Greece said it expects to receive its €8B tranche of bailout money in September, however expect the Germans to require a positive report from the mission before the bailout tranche is paid.
(9/18) State Elections in Berlin. Is Merkel’s party on the chopping block again?
(9/29) Germany votes on EFSF. On Sunday Merkel’s CDU party lost state elections in Mecklenburg-Vorpommern, her home-state, to the Social Democrats (SPD). The loss raises questions on Merkel’s support for the EFSF. Remember, confidence in Merkel has waned and her party has lost 5 regional elections this year. Doubts have circled on Merkel’s ability to maintain a majority in her coalition, and if so, if she’ll be able to garner enough votes to pass the EFSF. The news agency Dapd reported today that more than 19 lawmakers refused to support expanding the powers of the EFSF (Merkel has a 19 vote majority).
Matthew Hedrick
Senior Analyst
