Positions in Europe: Short EUR-USD (FXE); Cover Italy (EWI) today
The magical European Bazooka Wand didn’t come out this weekend, and we don’t expect to see it at the EU-Summit on October 23rd either. Eurocrats have much on their plate, including bank recapitalization procedures, expanding the EFSF, and broader measures to insulate risks to the PIIGS. At odds remains the ECB’s unwillingness to take on more exposure, either directly through the EFSF or its bond purchasing program (SMP), and indecision from Eurocrats (and IMF) on Greek debt haircuts (21% vs likely reality of 50-60%), Eurobonds, higher capital standards for banks (including for future stress tests), and member nation default.
The European bag of risk continues to be directed by headlines, most particularly by the expectations that the “next” Eurocrat meeting will bring a positive solution to the region’s ills. Here we’ll repeat our bearish outlook on European capital markets. We think any relief rallies over the immediate term will be short lived, including for the EUR/USD – Europe has structural long term issues that will not be solved with the snap of a finger. We would however point to the November 4th G20 meeting as a likely date for additional direction to the banking and sovereign crisis. Quantifying last week’s bounce, European equity indices rose between +4 to 6% and the EUR-USD cross gained +3.8%.
In this light, we remain short the EUR/USD and find it prudent to be short select markets or on the sidelines until the details of Big Bazooka are revealed. The EUR/USD continues to be broken on its intermediate term TREND ($1.43) and long term TAIL ($1.39). Today Keith tactically covered our short position in Italy (EWI) in the Hedgeye Virtual Portfolio, however longer term we remain bearish on Italy. It was just Friday that Berlusconi won a narrow confidence vote, demonstrating just how fragile his rule remains, which creates huge political headwinds as the market judges the broader Italian economy on his ability to secure budget cuts in the coming 1-3 years.
Below we show our typical Monday risk monitor charts. Of note is that Italian yields (currently at 5.78%) are creeping dangerous close to the 6% level, a historically significant break-out line for Greece, Ireland, and Portugal, and the spread between German bunds and the 10YR French yield is at a decade wide of 95bps today. As we've said before, a downgrade of France's AAA credit rating is a real possibility that would have disastrous effects across the region, including undermining the EFSF.
A look at sovereign cds shows that Irish, Spanish, Italian and French spreads were slightly wider week over week, while Portuguese and German spreads tightened week over week. In particular, German CDS tightened by 8.9% (see charts below).
Finally, our European Financials CDS Monitor showed that bank swaps mostly tightened in Europe last week. Swaps tightened for 37 of the 40 reference entities. The average tightening was 7.2%, or 36 basis points, and the median tightening was 5.0%. Spanish banks saw the least tightening of the group.