Markets Give Thumbs Down on Greece Aid
While Angela Merkel is off trying to sell the Greek aid package to German voters in the run-up to a crucial regional election in Germany, the markets have already voted on the 110 billion Euro EU/IMF deal: thumbs down.
Win Thin of Brown Brothers Harriman says:
Markets have given a clear “thumbs down’ to the Greek aid package. Greek 2-year yields have surged 379 bp today to over 14%, and is dragging the rest of the periphery along. Portugal 2-year yield is up 67 bp, Ireland up 25 bp, Italy up 15 bp, and Spain up 25 bp. Greek CDSs are trading near 730 bp, below the highs around 850 bp last week but clearly still elevated. In other words, the markets are telling us that the aid package has not lessened default risk by any significant amount. Remember, the entire Greek aid package is predicated on getting market borrowing rates back down so that Greece can issue new debt for the private sector and stay current on its current debt load. That’s not happening yet.
The euro is making new lows for the cycle against the dollar, and concerns about Greece are helping to soften up EM currencies today as well. Not surprisingly, EMEA currencies are getting hit the hardest, with worst performers vs. USD today HUF, PLN, ZAR, CZK, and RON. We remain most bearish on EMEA within the EM space, and most bullish on Asia. Eastern Europe is highly dependent on exports to Western Europe, and we see sub par euro zone growth continuing for several years. RON was probably not helped by a 25 bp cut today in the policy rate to 6.25%, a record low, while ZAR sentiment may have been hurt by report that unemployment rose to 25.2% in Q1 from 24.3% previously. We think a rate cut is very likely at the next SARB meeting May 13. Bottom line: EMEA is going to be saddled with a combination of slow growth and the need for stable to lower interest rates, while Asia is enjoying strong growth and a rising need for tighter monetary policy.
Meanwhile, in Spain, the Spanish media are wondering where the 10 million euros are going to come from that Spain is contributing to the aid package. In fact, Spain is contributing more per capita (586 Euros) to Greece’s aid package than Germany (563 Euros). The Portuguese are contributing 2 billion or 534 Euros per capita. Ireland comes in at 1.28 billion or a gargantuan 819 Euros per capita.
Given the fiscal burdens already on these countries, it isn’t credible that they would be able to loan Greece money. But that is what is expected now that the Euro crisis has spiralled out of control. The markets aren’t buying it.
I get it now. Have the poor countries of Europe (Spain, Portugal, Ireland) bailout the Greeks! HA!!! Borrow from Beggars! But it’s just like here in the USA. To overcome the worst borrowing and spending binge in the history of the world the boyz want easier credit and lending and borrowing and spending to cure the excess. Talk about contagion. Did our silly ideas really cross the Atlantic and infect them over there?
A glimpse into financial hell
Posted by Neil Hume on May 04 14:40.
Alan Ruskin has peered into the abyss of a US sovereign debt crisis to see what the world might look like. Unsurprisingly, it’s not a nice place.
Food commodities would be about the only thing left worth owning, according to the RBS strategist.
Now, Ruskin is not forecasting a 70’s style Treasuries sell-off, but he reckons this is a fat tail risk worthy of serious consideration given that politicians will need to have their feet raked over coals before behaving responsibly.
Welcome to financial hell:
The US Treasury market is large, but by the size of global financial assets it is still surprisingly small. If we use end 2008 IMF data (because this data is complete and the last year will not have changed the big picture) US treasuries make up 25% of global public sector debt securities; 9.5% of public plus private sector debt securities; 7.5% of bank assets; and a modest 3.5% of all private & public sector debt plus equity plus bank assets. In other words there are plenty of other assets to own in the world. However, that would not help much if there was a run on US treasuries.
The first problem is simply one of correlation. Almost all the above assets, private debt, bank assets and equities will be especially highly correlated with US Treasuries in a crisis. The second problem is that Treasuries, even if they stand at the epicenter of the crisis, are likely to be the low beta asset. The majority of the $220+ trillion in global bond, equity and bank assets would be leveraged off global growth and remain high beta relative to Treasuries, losing even more value were Treasuries to collapse. This probably also applies to many real assets in the short-term, especially those that are interest rate sensitive.
A Treasury collapse story presumably would very quickly evolve into too many risky assets chasing far too few ‘risk free’ assets. What are the risk free assets they would choose? Gold, the barbaric metal, would presumably feed handsomely off such sovereign risk savagery! But the total gold market is estimated to be only about $6.5trillion, or smaller than the Treasury bond market, of which only a little over $5 trillion is in private hands. Worse still, the daily gold turnover is only 2% of major currencies! Such a slow churn, coupled with fixed supply, would drive prices parabolic, and the choice of buying gold would quickly start to feel like it did to the average Dutchman in the 17th century, when a single tulip rose to an average of 10 times annual income.
Foreign bond markets could provide an alternative, if tax revenues could hold up somewhere in the world, but all debt markets outside the G3 are tiny relative to global assets. For example even the German Bund market makes up less than 2% of global debt securities, and this is roughly three times all of Asia NIC public debt if you were looking for an emerging market ’safe haven’. In a topsy-turvy world where the risk pyramid inverts, and the developing world risk converges further versus the developed world, emerging economy bonds, equities and bank assets still provided limited opportunities, making up a mere 14% of these same developed world assets.
And here is Ruskin’s conclusion:
The above clipped analysis tends to lead to an unlikely conclusion: One of the unique sources of Treasury value, is that as it goes down, it destroys more value in most substitutable assets than it loses itself, which perversely then provides some support! Put another way, one of the sources of Treasury ‘quality’ is precisely its ability to destroy value (quality) in competing assets! In the hierarchy of assets it makes a difference whether assets are dependent on other assets, or whether they lead other assets, as the Treasury market does. It is also doubtful whether another benchmark sits in the wings, for no other economy is big enough and has the global interconnectivity whereby changes in the long-term price of money reverberate around the world the way US treasuries do.
Now a US Treasury crisis should also never have to extend to default, as long as the Fed is willing to buy US Treasury debt, and deliver the haircuts to investors through inflation rather than direct restructuring – which may be preferable for reputational interests. Unfortunately the inflation route is still desperately painful, not least because it drives up nominal yields and delivers the pain incrementally through bond and currency losses, rather than all upfront as a restructuring. Such bond losses are indicative of how a fiscal funding crisis quickly ends up as a monetary policy crisis, and a collapse in central bank control across the curve.
Although this all feels like jumping deep into the land of the hypothetical, the above scenario is not too far removed from the late 1970s period of stagflation. I have gone back a good deal further, to the start of the 20th century to see how assets coped with stagflation (a relatively rare phenomenon) which would be the likely backdrop to (or outcrop of) a US sovereign crisis. The conclusions are not pretty.
As feared there have been very few places to hide outside commodities when US growth is very soft and inflation is above a 5% threshold. Sell, equities, be a big seller of BAA then AAA bonds and yes buy FOOD commodities. Food commodities have been up as much as 30% y/y in years since 1900 when US per capita income was negative and inflation is above 5%, perhaps because these conditions are also accompanied by energy shocks or war, that are among the other darkest channels to financial blight.
Thanks for the link.
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