No Active Positions in Europe
Manic Europe is again trading on rumors out this weekend and the fumes of optimism that Europeans can issue a bazooka to cure the region’s structural ills in one blast. Our outlook is overweight Eurocrats dragging their feet to maintain the fabric of the Eurozone without answering the harder structural choices over the near term. Here we’d expect the EUR/USD cross and Europe’s equity markets to trend lower so long as there are no clear details or intentions of a bazooka in the works. (We covered our positions in the EUR/USD (FXE) and France (EWQ) in the Hedgeye Virtual Portfolio on 11/23).
Remember, the German and ECB position remains that the ECB will not be a vehicle to leverage or expand the ECB and the Germans stand against the issuance of Eurobonds. However, we think these positions will have to be amended as there’s a lack of additional options: the IMF is not in a position to solely boost the EFSF and individual parliaments of the member states will not give the political vote to expand the taxpayer’s contribution to the facility.
Official discussions of Europe’s next major step will begin as soon as tomorrow’s two day Eurogroup/ECOFIN Finance Ministers’ meeting and could focus on establishing a fiscal union, essentially a German-French and/or Brussels-based babysitter to monitor the fiscal (namely budget) choices of member states, basically the Growth and Stability Pact 2.0, with the intentions of actually being adhered to this time around. Other calendar catalysts to be aware of are:
2. December - German Chancellor Merkel delivers a speech on the crisis to the lower house of parliament in Berlin
8. December - ECB Interest Rate Decision
9. December - EU Summit
Perhaps further down the road this fiscal union could be integrated/amended into the EU treaties, but this “Fast Track” approach would seek short-term implementation to send a positive signal to the market that Europe is on the road to improving its fiscal house with the fiscally stronger states calling the shots (in particular Germany). Longer term, this fiscal union could be amended into EU treaties. However, we don’t think that a fiscal union alone will support a sustained rally in European capital markets, but will be one step in the right direction. Logistically there’s a ton of unanswered questions about such a fiscal union, so communication will be essential.
While it’s hard to size up the look and feel of this “Fast Track” approach, it’s clear that Eurocrats are feeling the pressure of tied hands when responding to the market’s movements. As the spotlight shifts towards the risks of the Eurozone’s larger nations of Italy and Spain and talk of Greece’s exit from the Eurozone, headline risk will continue to weigh substantially. Over the weekend it was rumored by the paper La Stampa that the IMF may make a €400B-€600B loan to Italy at below market rates of 4%-5%. The IMF has squarely denied this article, and this rumor is easy to refute as the sum represents over half of the IMF’s existing lending capacity, nevertheless many European equity indices finished today’s session up +250 to 500bps and intraday the EUR/USD is bid up 0.50%.
Given the volatility of the rumor mill we’re pleased with our decision to cover the EUR/USD on 11/23 near our oversold level of $1.32. We see the EUR/USD trading up to an immediate term resistance level of $1.34 and should it run through $1.37, we’d change our bearish outlook.
Below we present our weekly risk monitors.
European Equity and Currency Moves – European markets today largely made up for loses last week, however week-over-week (Friday-over-Friday) indices fell 3-5% with negative divergence from Italy’s MIB -8.5%; Greece’s Athex -6.8%; and Austria’s ATX -6.5%. Over the same duration, the EUR/USD was down -2.1%.
European Sovereign Yields – European 10YR yields were mostly higher last week. Of note is the sustained move of German yields. The 10YR was up +41bps week over week to 2.30%, a clear risk signal that even the region’s fiscally strongest nation is under threat.
Greek yields declined -115bps as the sovereign debt spotlight shifted more squarely on Italy and Spain. Portuguese yields widened the most, +209bps to 13.38%, followed by Italy (+39bps to 7.09%). To round out the PIIGS, Spanish yields rose +6bps to 6.62%. As always, we’re keying off the 6% Lehman line as a critical breakout line. Italy and Spain have held tight above the 6% for the last five weeks.
In its SMP bond purchasing program, the ECB bought €8.6 Billion in secondary bonds last week (vs €8.0B in the week prior), taking the total program to €203.5 Billion. Look for Super Mario (Draghi) to increasing buying alongside heightening Italian yields.
European Sovereign CDS – European sovereign swaps mostly widened last week. German sovereign swaps widened by 15.3% (+15 bps to 111.5) and American swaps by 7.8% (+4 bps to 55.5).
European Financials CDS Monitor – A Sea of Red. Bank swaps were wider in Europe last week for 35 of the 40 reference entities. The average widening was 5.4% and the median widening was 16.1%. Bank swaps remain below 300 in Norway, Sweden, Switzerland, and the UK. Across the 29 banks in Austria, Belgium, Denmark, France, Germany, Greece, Italy, Portugal, Russia, Scotland, and Spain, there is only one bank with swaps trading below 300 bps. While no one needs reminding that the systemic risk in the European banking system is extraordinarily high, this morning's data serves as a reminder nonetheless.
Matthew Hedrick
Senior Analyst
