Positions in Europe: Short EUR/USD (FXE)
Asset Class Performance:
- Equities: European indices were up across the board for a second straight week, in a range of +100 to 350bps week-over-week. Top performers: Cyprus 20.9%; Romania 7.0%; Greece 5.3%; Austria 5.3%. Bottom performers: Switzerland -1.5%; Portugal -90bps.
- FX: The EUR/USD +2.2% week-over-week. Divergences: HUF/EUR +3.4%, PLN/EUR +2.1%, RUB/EUR +1.8%, CZK/EUR +1.2%; Iceland Krona/EUR -1.1%.
- Fixed Income: 10YR sovereign yields broadly decreased w/w, with Portugal the exception gaining 25bps [vs +216bps last week] to 14.87%. Greece led the declines at -65bps to 33.52%, followed by Spain -53bps to 4.96% and Belgium -40bps to 3.70%.
***When the equity markets of Cyprus, Romania, and Greece are leading performance year-to-date, the world’s markets are in a very perverse state. Our main question in the second half of this week was: is Greece’s equity performance attributable to inside information on the PSI deal getting done? We remain cautiously short the EUR-USD (more below) and extremely cautious on taking an investment position in Europe given the political risk of Eurocrats and various agencies (ISDA, IMF, and the big three Credit Ratings Agencies, to name a few). Another peculiarity of the week remains that sovereign CDS continues to trend higher as sovereign yields and the Euribor-OIS continue to come in. Portugal, however, bucked this trend with yields and CDS rising (more below). Advanced Manufacturing and Services PMIs looked better in January across the major economies and the major bond auctions across the region proved successful in meeting demand and issuance at lower yields. This coming Monday’s report of the ECB’s SMP bond buying last week may be telling (high).
- Greece’s PSI debt-swap talks remain unresolved for another week:
- IIF’s Charles Dallard says creditors have now made their “maximum'” offer and any further demands are likely to jeopardize a “voluntary” deal and trigger a default along with CDS contracts. The decision now falls to the EU/IMF on whether to accept the terms. Last week the IMF was pushing for the coupon on the new bonds in the 3.0%-3.5% range which would take the NPV of losses for the bondholders above 70% versus the 68% they had reportedly been willing to accept with a 4.0%-4.5% coupon.
- European Union foreign ministers agreed to ban oil imports from Iran.
- EU data predicts for the 17 nations in the euro, only Estonia, Finland, Luxembourg, Slovakia, and Slovenia will be below public debt levels of 60% of GDP in 2012.
- BOE minutes: voted 9-0 to keep asset purchases unchanged at 275 billion pounds
- BOE Governor King said, “With inflation falling back and wage growth subdued, there is scope for interest rates to remain low, and, if necessary, for further asset purchases, to prevent inflation falling below the 2% target.”
Portugal On Uncertain Footing, Continued:
***This week saw a huge expansion of risk in Portugal in the form of rising CDS and sovereign yields. Growth, projected at -2.2% this year, will be a great challenge for the country as it runs the course of fiscal consolidation. We think there’s an outsized probability that Portugal misses its deficit target for a second straight year and its banks struggle to refinance and raise debt given its credit junk status.
Here are some contributing factors weighing on investors:
- Portugal may be forced to impose a 50% haircut on its private creditors as well.
- A report from the Kiel Institute for the World Economy said Portugal would have to run a primary budget surplus of over 11% of GDP a year to prevent debt dynamics spiraling out of control, even in a benign scenario of 2% annual growth. David Bencek, the co-author, warned that no country can achieve a primary budget surplus above 5% for long. The Institute said the haircut for Portugal would need to be 56% to put the country back on a sustainable path if long-term growth was 2%, or 46% if growth rose to 4%. The IMF expects Portugal's public debt to peak at 118% of GDP in 2013. (1/25/12)
- Speculation that Portugal may need another 30 Billion in EU/IMF rescue funds. According to Antonio Saraiva, the leader of the country’s industry confederation lobby, and because of the debt crisis, foreign banks have stopped refinancing Portuguese debt, which forced Portuguese banks to step in and deprived the rest of the economy of loans needed for it to pull itself out of the worst recession in decades. (1/25/12)
- Standard and Poor’s downgraded Portuguese credit rating to Junk. (1/12/12)
- Portugal’s central bank forecast the economy to contract -3.1% in 2012 in its Winter report, versus a Fall forecast of -2.2%. (1/10/12)
- Outsized shadow economy that doesn’t pay tax, which has been reported by the OBEGEF Economy and Fraud Monitoring Observatory to have grown 2.5% in 2010 to 24.8% of GDP, or €8B in lost revenue.
Carlos Moedas, Secretary of State to the Prime Minister of Portugal, presents an entirely different tone (one we find overly optimistic) on his outlook on Portugal in an article titled: Portugal Is Beating the Headwinds that was published in the WSJ on 1/26. See his comments here:
Pain in Spain, Continued:
This week two key Spanish Finance Ministers disagreed on the country’s deficit target. Economy Minister Luis de Guindos said Spain is sticking to its deficit goal even as the economy shrinks, whereas Budget Minister Cristobal Montoro’s called for the EU to ease Spain’s 4.4% of GDP deficit goal for 2012, as the figure was based on the previous government’s 2012 growth assumptions of +2.3% versus the Bank of Spain’s recent 2012 GDP estimate of -1.5%.
Spanish Prime Minister Mariano Rajoy affirmed this week that the target will be met. [Last year, the Spanish deficit amounting to 8% of GDP versus its target of 6%]. And EU Economic and Monetary Affairs Commissioner Olli Rehn rejected Montoro, said it’s “essential” that Spain meets the target.
Since Rajoy was elected on November 20th, the rate on 10-year Spanish debt has declined 159bps to 4.965%, however fundamentals don’t look rosy.
The unemployment rate stands at 22.9% in November and a housing overhang persists, preventing the market from clearing as banks remain reluctant to liquidate “troubled” assets that the Bank of Spain has estimated at €176B.
Last year house prices fell -8.2%, versus -17% since prices peaked in 1Q 2008. An issue that stands unanswered is if Rajoy will commit public funds to banks to bleed their “troubled” assets, a position he’s avoided as he focuses on bringing down the government’s deficit. According to an interview by de Guindos he’s “absolutely” ruled out setting up a so-called bad bank to acquire damaged assets from lenders, saying the cleanup process won’t “cost a penny more” to the taxpayer.
Merkel at the Pulpit and ESM vs EFSF:
***There’s been much talk this week about the permanent European Bailout Fund, named the European Stability Mechanism (ESM) that is effective July 2012 and currently stands at €500B. Italian Prime Minister Mario Monti said the ESM needs to be increased, whereas Merkel takes a more cautious tone on setting expectations and managing the “crisis”.
On calls to increase the size of the ESM, German Chancellor Merkel said, “Some say that it has to be double the size, then if that’s not big enough, others will say it has to be three times as big. What we don’t want is a situation in which we promise something that we can’t back up.” -Opening speech of Davos, 1/25/12.
On the direction to bind the Union, she said: "We will only be able to strengthen our common currency if we co-ordinate our policies more closely and are prepared to gradually give up more powers to the EU. If we make loads of promises about debt reduction and sound budgeting, those need to be things that can be enforced or brought to court in the future. The point of the fiscal compact, after all, is to make it possible to check on those commitments. That means giving our [European] institutions more monitoring rights – and more bite."
On Greece: “Of course, there's Greece, a special case where, despite all the efforts that have been made, neither the Greeks themselves nor the international community have yet managed to stabilize the situation."
On Eurobonds: Merkel again ruled out pooling Eurozone debt – Eurobonds – as a quick fix to the crisis, but left the option open should the new euro regime produce results. -Interview with The Guardian 1/25/12
Key Sovereign Bond Auction Prove Successful This Week:
- Spain sold €2.51 billion in 3-6M bills on 1/24 with an average yield on 6M 1.847% vs 2.435% on Dec 20.
- Germany sold €2.46 billion in 30YR bonds on 1/25 with an average yield of 2.62% versus 2.82% prior.
- Italy sold €5 billion of zero coupon bonds on 1/26 maturing in Jan. 2014 with a yield of 3.763% vs 4.853% on Dec 28.
- Italy successfully sold its target of €11 billion in bonds on 1/27 with an average yield on 6M bills at 1.969% vs 3.251% on Dec 28.
PMI Manufacturing (Preliminary JAN):
France 48.5 JAN (exp. 48.6) vs 48.9 DEC
Germany 50.9 JAN (exp. 49) vs 48.4 DEC
Eurozone 48.7 JAN (exp. 47.3) vs 46.9 DEC
France 51.7 JAN (exp. 50) vs 50.3 DEC
Germany 54.5 JAN (exp 52.5) vs 52.4 DEC
Eurozone 50.5 JAN (exp. 49) vs 48.8 DEC
Key Regional Data This Week:
Germany GfK Consumer Confidence 5.9 FEB vs 5.7 JAN
Germany IFO Business Confidence 108.3 JAN vs 107.3 DEC
Germany IFO Current Assessment 116.3 JAN vs 116.7 DEC
Germany IFO Expectations 100.9 JAN vs 98.6 DEC
Germany Import Price Index 1.0% Q4 Y/Y vs 2.7% in Q3
France Business Confidence Indicator 91 JAN vs 94 DEC
UK Q4 GDP -0.2% Q/Q (exp. -0.1%) vs 0.6% Q3
Spain Unemployment Rate 22.9% in Q4 vs 22.2% estimate (highest level in 15 years)
CDS Risk Monitor:
***On a w/w basis, CDS was largely down across European sovereigns, with Portugal the exception for a second straight week. Italy saw the biggest declines at -62bps to 409bps, followed by Ireland -30bps to 623bps, and Spain -19bps to 362bps. Portugal gained +163bps (versus +169bps last week) to 1420bps (see charts below).
***Keith shorted the EUR/USD via the eft FXE on 1/19 in the Hedgeye Virtual Portfolio with the price bumping up against our immediate term TRADE resistance level of $1.29. We’ll be watching this position closely as our bullish outlook on the US Dollar greatly changed this week given the debauchery messages from President Obama (State of the Union Address) and Federal Reserve Chief Bernanke (FOMC Press Conference).
The European Week Ahead:
Monday: EU Summit; Jan. Eurozone Consumer Confidence - Final; Jan. Eurozone Business Climate Indicator; Jan. Eurozone Consumer, Economic, Industrial, and Services Confidence; Jan. Germany Consumer Price Index – Preliminary; Jan. UK GfK Consumer Confidence Survey; Jan. Italy Business Confidence; Q4 Spain, Ukraine, and Lithuania GDP – Preliminary
Tuesday: Dec. Eurozone Unemployment Rate; Jan. Germany Unemployment Rate and Change; Dec. UK Money Supply; Dec. France Producer Prices and Consumer Spending; 2011 Russia Annual GDP; Dec. Italy Unemployment Rate – Preliminary and PPI
Wednesday: Jan. Eurozone, Germany, and France PMI Manufacturing – Final; Eurozone Jan. CPI Estimate; Jan. UK House Prices and PMI Manufacturing
Thursday: Dec. Eurozone PPI; Jan. UK Lloyds Business Barometer; Dec. UK PMI Construction; Jan. Spain Unemployment
Friday: Jan. Eurozone PMI Composite and Services – Final; Dec. Eurozone Retail Sales; Jan. Germany and France PMI Services – Final; Jan. UK PMI Services and Official Reserves; Jan. Italy CPI – Preliminary and PMI Services
Extended Calendar Call-Outs:
16 February: Allegedly the “new” PSI deadline, but more practically, 20 March.
29 February: 2nd 36-Month LTRO Allotment
25-26 February: G20 Finance Ministers Meeting in Mexico City. Decision on IMF loan of €500B expected
20 March: Greece’s €14.5B Bond Redemption Due
30 June: Deadline for EU Banks to meet €106B capital target/the 9% Tier 1 capital ratio
1 July: ESM to come into force