Position: Long Germany (EWG); Short France (EWQ)
While the size of Europe’s loan facility, the €750 Billion Keynesian Elixir, came as a surprise to us, we’ve been vocal that the aid package will offer at best near term support to lessen contagion fears, and is far from a panacea. The European governments that have overextended their balance sheets—mainly the PIIGS—must bite the bullet and issue austerity measures to quell their debt imbalances (or restructure), else they’re simply kicking the can of debt and future inflation further down the road, which will not end well. What’s clear is the direction for Europe is still very unclear. Certainly while investors’ near-term fears have lessened (see charts 1 and 2 below of CDS and bond yields from the PIIGS), the Euro is shaking against the UDS (clearly not the outcome Trichet hoped for) and the equity markets in Europe are volatile (charts 3 and 4). We stick by our Q2 Theme of Sovereign Debt Dichotomy in which we noted that one way to play the spread is to be long Germany and short Spain. Currently the YTD spread between the German DAX and Spain’s IBEX 35 is over 1700bps.