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We don’t get the media’s freak-out over Ireland over the last two days, but agree that the increase in investor fear is a natural consequence of Standard & Poor’s cutting the country’s credit rating one step to AA-. In its report, S&P increased its estimate for recapitalizing the banking system to as much as €50 Billion ($63 billion) from a previous estimate of €35 Billion. In summary, we believe that more pain could be ahead for the island nation.

From a fundamental perspective we’ve yet to see meaningful improvement from the country over the last months. Despite improvement in quarter-over-quarter GDP to +2.3% in Q2, Ireland has the highest budget deficit in Europe at 14.3% of GDP; unemployment at 13.7%; and banking and housing issues that loom, including news that the Bank of Scotland has decided to pull out of Ireland in the new year, which could negatively impact the hotel sector in particular. And further data shows that its important tourism industry is suffering. According to the Central Statistical Office Ireland, the number of overseas visitors to Ireland between January and May in 2010 stood at 2,026,100, down from 2,951,800 in the same period in 2008, or the equivalent to a drop of 6,130 visitors per day.

In context, Ireland’s economy is ~ 1/15 the size Germany’s; we’re nevertheless mindful of the impact that the periphery (PIIGS) can have on the region.  Below we chart increases in the risk premium via sovereign bond yields and CDS prices over recent days from the PIIGS, while the economies of Germany, France and the UK remain front and center on our screens as a greater gauge of the region’s health. Importantly, over recent days we’ve seen the TREND line (3 months or more) in the DAX and FTSE break, decidedly negative factors in our model, and an initial signal of the trouble ahead that we’re forecasting for Europe in the back half of the year. Our TREND lines for the DAX and FTSE are 6075 and 5293, respectively.

Further, the initial data out in August has largely been in line with our forecast for a negative inflection in August:

  • Germany’s ZEW confidence survey showed a material decline in economic sentiment to 14 in August versus 21.2 in July
  • Manufacturing and Service PMI numbers largely slid for Germany, France and the Eurozone
  • The German IFO Business climate survey for expectations 6 month ahead declined, from 105.6 in July to 105.2 in August

As a reminder, we believe the legacy of European sovereign debt is by no means rear-view, including the question of bank exposure to sovereign debt, which was largely unaccounted for in the 91 bank stress test. Further, continued fiscal and political weakness throughout the region should persist (in Greece and Hungary in particular).

Tomorrow Ireland will issue between 400-600 Million Euros of bills. This is but one immediate term hurdle to keep your eye on.

Matthew Hedrick


Looking for Fear? - mh1

Looking for Fear? - mh2