Positions in Europe: Short France (EWQ)
On this Monday the 7th of November it is acutely evident how governed capital markets are to the political positioning of European leaders.
As expected, nothing concretely came out of the G20 meetings on Thursday and Friday on the big three issues: expansion of the EFSF, the terms of bank recapitalization (contingency if bank not able to meet a 9% capital ratio), and Greek haircuts. One topic that was given much attention was expansion of the IMF’s contribution to the EFSF, however here too there was no consensus or concluding statements. Finally, the Chinese remain on the sidelines as a “white horse” bailout candidate.
The political risk however has mounted over the last week. Papandreou won the confidence vote late Friday in exchange for his consent to be replaced as PM, the announcement of which could come this week. The front runner looks to be the current Finance Minister Evangelos Venizelos. As we’ve said all along, Papandreou’s decision to call a confidence vote and referendum on the bailout package was reckless—despite his attempt to win the backing on his fellow citizens, Greece is taking its orders from Brussels to meet its nearest maturities and pay its pensioners and government workers to addressing its longer term issues of reducing its outsized deficit and debt loads. Look for an interim government to be formed, probably with the PASOK party holding a slim majority in Parliament over the next months, or as long as is needed for the country to secure its next bailout, before early elections may be held at the end of February or early March.
Shifting westward, Italy’s political machine appears on the verge of cracking. However, this time around what’s on the line doesn’t seem that different from previous months—Berlusconi’s credibility, or the lack thereof. The authoritarian Berlusconi this time around seems bent on intimidation as the parliament must sign-off on the 2010 budget tomorrow. This weekend saw mass rallies calling for his resignation and two Berlusconi allies defected to the opposition last week, and a third quit on Sunday. What should be a routine measure, as this after all is the 2010 budget, did not receive a majority when it was called last month, which caused a confidence vote that Berlusconi narrowly won. This time around, we may see a different outcome. Bond yields (more below) are reflecting this risk. Ultimately, the fractured state of Italian politics bodes poorly for the international community’s expectation for budget consolidation over the coming years to bring in the country’s ballooning debt (119% of GDP).
Finally, France issued another austerity package this morning worth €18.6 Billion in spending cuts and tax hikes. While austerity is needed to reduce budget debt levels, expect this package to not cure market concerns that its AAA credit rating could be reduced. For more, see our post on 11/2 titled “Shorting France”.
Turning to the ECB, its secondary bond purchasing program, the Securities Market Program (SMP), upped its purchases in the week ended November 4th to €9.5 Billion, bring the program to €183 Billion collectively since May 2010. In his first week as ECB president, Draghi not only cut the main interest rate by 25bps, but may soon realize how necessary the Bank’s purchases are in attempts to quell Italian yields, despite the mandate that the SMP is a temporary program.
Unfortunately, what’s clear is that there are no major meetings scheduled into year-end around which we’re likely to get resolve on Europe’s big issues. This portends that Eurocrats will be held hostage by the market and will likely call short term meetings to answer big-term questions in response to ballooning risk. While equity markets may have perversely gained today in Greece and Italy on leadership changes, we’ll continue to take our cues from bond yields and expect more downside in European capital markets than upside into year-end, as the region has yet to deliver any confidence to the market in concrete terms on further subsidizing the member states.
A look at our risk metrics below tells a clear story.
European Bond Yields – European bond yields across the PIIGS were up week-over-week, with Greek 10YR yields jumping a full 460bps from Friday’s close to today’s intraday level of 27.98%, as Italy’s 10YR jumps to a new high of 6.66% intraday!
European Sovereign CDS – European sovereign swaps mostly widened last week. Spanish sovereign swaps widened by 18% (+60 bps to 399) and Italian by 19% (+82bps to 516). US CDS widened off a low base, rising from 40 bps to 48 bps.
European Financials CDS Monitor – Bank swaps were wider in Europe last week for 36 of the 40 reference entities. The average widening was 7.6% and the median widening was 14.6%. Swaps for Credit Agricole and the Deutsche Bank widened 31.7% and 31.3% respectively. The nine French and German banks we track saw swaps widen an average of 19%.