Positions in Europe: Short France (EWQ); Short EUR-USD (FXE)
The status quo is not good enough. While heads have rolled in Greece, Italy, and Spain in recent days, and provided some short term bounces in specific capital markets, in our opinion a sustained bullish move will not come for European markets unless Eurocrats directly address: ( 1.) expansion (leverage) of the EFSF; (2.) bank recapitalizations (specifically for banks that cannot raise assets); and (3.) setting the rate of Greek haircuts to capture “voluntary” demand.
In the fray, however, remain much larger unanswered questions: Can EU treaties be amended to allow a country to leave or be kicked out of the Eurozone, but not the EU? Can Greece be ring- fenced as to not create a larger move of contagion across the 17 member states? Can a fiscal union work? Can the ECB’s SMP fend off rising yields in Spain and Italy, and will its secondary bond buying greatly expand and be deemed anything more than a temporary facility?
While there’s indication that Eurocrats (especially German Chancellor Angela Merkel at the top) want to maintain the existing fabric of the Eurozone and preserve the stability in the common currency, dialogue has shifted from top leaders and now core question like assessing if the unity of unequal states under one monetary policy is sustainable. And while there’s renewed talks of Eurobonds (a position supported by George Soros) don’t discount political indecision across borders and fiscally stronger nations’ (Germany, Netherlands, Finland) resolve to reject them (at least initially) as to not see their cost of capital rise.
While we can’t get ahead of the actions politicians will take in the coming months, we continue to take our risk cues from the credit market.
Here we’ve seen yields across the periphery sustain elevated levels, and most worrisome are the recent breakouts in Spain and Italy, both now flirting around the 7% level on the 10YR, economies far larger than Greece, Portugal and Ireland combined, which cannot be contained in the case of a default or cracks across their sovereign debt and banking exposures given the existing size of the EFSF. We’ve also seen no change in the ECB’s position, backed by Germany, that it will directly intervene to support the region via leveraging the EFSF or buying primary issuance.
Given this “treading water” profile of inaction we’ll remain short the EUR-USD via the etf FXE in the Hedgeye portfolio, and remain short France (EWQ). We see the EUR-USD broken on its intermediate term TREND ($1.42) and long term TAIL ($1.40) levels. We’d expect the pair to TRADE over the immediate term TRADE between $1.33 and $1.35, and should it break its downside support level we do not see material support until the $1.21 line.
Below we present our weekly risk monitors.
European Equity and Currency Moves – On a week-over-week basis (Friday to Friday), European equity indices fell largely between -3% and -7%, with the outliers to the downside Austria (-7%, threatened by write off and banking exposure to Eastern Europe) and Cyprus -12.3%. Swiss equities were a relative outperformer, falling only -60bps w/w. YTD notable equity indice declines include: Greece Athex -52%; Austria ATX -41%; Finland OMX -32%; Portugal PSI -31%; and Italy FTSE MIB -28%. The EUR-USD finished down -1.6% w/w.
European Sovereign Yields – European 10YR yields were mixed last week. Greek yields declined -27bps; while Spanish yields gained +60bps and Italian +13bps. As always, we’re keying off the 6% Lehman line as a critical breakout line. Italy and Spain are holding tight above the 6% for the last four weeks.
In its SMP bond purchasing program, the ECB bought €8 Billion in secondary bonds last week (vs €4.5B in the week prior), taking the total program to €194.5 Billion. Look for Super Mario (Draghi) to increase buying alongside heightening Italian yields.
European Sovereign CDS – European sovereign swaps mostly widened last week. Spanish sovereign swaps widened by 8% (+36 bps to 463) and French by 12% (+25 bps to 227).
European Financials CDS Monitor – Bank swaps were wider in Europe last week for 39 of the 40 reference entities. The average widening was 8.1% and the median widening was 13.6%.
And just this morning Bank of Spain nationalized Banco De Valencia, a small Spanish bank, yet nevertheless is likely an initial sign of more to come.