Positions in Europe: Short EUR-USD (FXE); Short Italy (EWI)
How the European sovereign debt and banking contagion crisis churns… Sunday’s meeting between Merkel and Sarkozy on measures to recapitalize European banks targeted the announcement of a bailout bazooka (size and scope still undermined) by the G20 Summit on November 3/4 in Cannes. That gives us a runway of 3.5 weeks of indecision—and while today’s rally across European equity markets and in the EUR-USD pair reflects “hope” in a bailout’s impact on capital markets, from here we’re positioned to short or fade these intermediate term rallies that the inevitable Bazooka will not be able to address—that is the deeper structural problems that cannot be cured with the snap of a finger or the stroke of the pen.
As the banking news out of Dexia and Erste over the last days has captured headlines, what’s clear is that so long as sovereigns remain at risk (and here we’re focused on Italy and Spain beyond the much smaller but critical risks of Greece, Portugal and Ireland), the European banking system will remain at risk due to its interconnectedness.
Keith re-shorted Italy via the etf EWI and the EUR-USD via FXE in the Hedgeye Virtual Portfolio today. Our thesis on Italy hasn’t changed and we’d point you towards our work titled “Shorting Italy (EWI)” on 9/30 for review. The EUR-USD remains in a decidedly Bearish Formation, which Keith highlighted in today’s Early Look. In short, such a set-up sees the current price below the long term TAIL line, intermediate term TREND line, and immediate term TRADE line. While we’re seeing intraday strength above $1.36 today, the set-up gives us strong downside conviction (see chart below).
We continue to keep our eye on European risks via government bond yields and sovereign CDS. Looking at government yields, the 6% yield line on 10 year government bonds remains a critical one that historically has market a breakout level (see chart below). Italy and Spain have maintained a level below 6% since the ECB restarted the SMP on August 8th, and currently trade at 5.57% and 5.01%, respectively, but look for any gains towards 6% to cause much market consternation.
European Sovereign CDS – European sovereign swaps were tighter week over week. German and French sovereign CDS spreads tightened by 15% and 7% respectively from last Monday to today.
European Financials CDS Monitor – Bank swaps mostly tightened in Europe last week. Swaps tightened for 26 of the 40 reference entities. The average tightening was 2.0%, or 10 basis points, and the median tightening was 3.3%.
Matthew Hedrick
Senior Analyst