As I said on August 1st:
With the economic world firmly focused on the US debt debacle this week it is likely that Europe will slip off the radar a little. I suspect, as many people do, that for the US there will be an eleventh hour resolution followed by a short lived bounce in the world markets. Once that bounce heads back to earth again it is likely that the world’s eyes will turn back to Europe.
Well, that is pretty much what happened last night and once again no one liked what they saw. CDS spreads are…well, spreading across Europe as a rumour that France was about to lose its AAA credit rating:
The price of Germany’s five-year credit-default swap, briefly overtook the U.K. for the first time Tuesday, while France’s CDS now trades close to double that of Germany’s.
Italian, Belgian and French CDS are closing at record levels as the iTraxx SovX Western Europe index climbs back above 300 basis points for the first time since mid July.
Markit says the SovX last closed above 300 bps on July 19. It notes the Italian five-year CDS spread is at 392 bps, above its record close of 385 bps on Aug. 6. Belgium’s CDS is at a record 279 bps, having closed at 253 bps on Jan. 10. French CDS is closing at 176 bps, 15 bps above the record close Tuesday.
“We’re not in risk-on mode, far from it,” says SocGen
SocGen would know. French banks, along with their German counterparts took a big hit hard last night because of write-downs over Greek debt and the appearance of new problems over debt re-scheduling. If you are a long term reader of mine you will not be at all surprised why we are now seeing new problems with Greece:
Greece’s ambitious reform program suffered a double setback Wednesday after it emerged that talks with the country’s creditors on a bond swap plan have stumbled and fresh data showed a sharp increase in the budget deficit.
Citing poor private sector participation, officials said that a plan to swap Greek government debt maturing by 2020 into new, longer-dated securities, might be extended to include bonds falling due in 2022 or even 2024.
This could be a further blow to European banks and insurers, which have been hit by their exposure to Greek sovereign debt following an agreed bailout package last month. Second-quarter earnings show an effective 21% loss on the net value of Greek bond holdings across Europe’s banking sector due to impairments on their Greek holdings.
As those talks stumbled, new finance ministry data showed Greece’s state budget deficit in the seven months to July 2011 widening 24.6% from a year earlier as revenue collections continued to lag.
In a statement, the Finance Ministry said that the cumulative state budget deficit rose to €15.51 billion in first seven months of the year—compared with €12.45 billion a year earlier, while net budget revenues fell 6.4% budget expenditures jumped 7.1%.
“The budget figures are a big disappointment, they are completely off track and suggest that Greece’s tax collection system has all but collapsed,” said Yannis Stournaras, director of the Foundation for Economic and Industrial Research. “And the extension of the bond swap program will mean a bigger impairment for the banks and that they will be forced to raise more capital.”
Don’t say I didn’t warn you. The Euro-elite however have learnt nothing over the last 12 months and continue to demand that member nations commit economic suicide while jawboning themselves into extending their bailouts:
European Central Bank chief Jean-Claude Trichet on Tuesday called on European governments, notably Italy and Spain, to “do their duty” in reducing public deficits and stabilising their finances.
“In sum, since the fall of Lehman Brothers, this is the worst crisis since the Second World War,” Trichet warned on Europe 1 radio, referring to the collapse of the US investment bank in September 2008 that triggered a global financial crisis.
In this context “we expect governments to do what we consider to be their work, their duty,” Trichet said.
“We have been extremely clear with the Italian government over recent days in asking for a number of decisions to be taken, which have been taken, and to speed up in particular a return to a normal budgetary situation,” he said.
“We have asked the same thing of the Spanish government.
So yesterday we saw the ECB intervene in both the sovereign bond and interbank markets as banks became increasingly nervous about lending to each other on the back of the new problems:
Key euro-priced bank-to-bank lending rates eased on Wednesday as the European Central Bank pumped fresh liquidity into the market with a six-month refinancing operation.
The ECB is also actively buying Italian and Spanish government bonds to halt sovereign debt crisis contagion to large euro zone economies.
The three-month Euribor rate EURIBOR3MD= — traditionally the main gauge of unsecured interbank euro lending and a mix of interest rate expectations and banks’ appetite for lending — dipped to 1.545 percent from 1.555 percent a day earlier, touching the lowest level since June.
Six-month Euribor rates EURIBOR6MD= fell to 1.741 percent from 1.745 percent, while longer-term 12-month rates EURIBOR1YD= fell to 2.083 percent from 2.086 percent.
Shorter-term one-week Euribor rates EURIBORSWD= fell to 1.222 percent from 1.281 percent, further below the ECB’s main rate, which is at 1.5 percent. EONIA overnight interest rates EONIA= fixed higher at 1.211 percent on Tuesday, the last day of the ECB’s reserve maintenance period.
Cash is not circulating in a regular fashion in the euro zone as jitters about the debt crisis grow. Banks deposited 63 billion euros at the ECB overnight and the central bank drained additional 145 billion in a fine-tuning operation.
Evidence of money market tensions has been widespread lately. Banks took a larger-than-expected 157 billion euros in the ECB’s handout of 7-day funding on Tuesday. They also took 76 billion euros in one-month funds.
The only thing holding Europe together at this point is the ECB’s balance sheet. But the question on everyone’s mind is “what next?”, and that is the problem we have seen all along with this European crisis. The complete lack of coordinated and decisive leadership and the lack of even a basic understanding of economics has meant that no one seems too sure what the plan is:
The European Central Bank is unlikely to escape its role as reluctant bond buyer anytime soon.
This week, the central bank finally gave the market what it yearned for: purchasing Italian and Spanish sovereign debt. The move was a controversial extension of a policy credited with quelling selling pressure on the bonds of financially strapped Ireland, Portugal and Greece.
Yields on Italian and Spanish bonds have fallen, indicating the ECB has managed to inject some calm into trigger-happy markets. But the fact that it’s buying bonds at all is indicative of how Europe’s debt crisis is mutating.
The ECB views buying distressed debt as a last resort, at best. Bond buying is outside the purview of what the central bank considers to be its central role: price stability.
The move also delays the possibility of what would be the ECB’s preferred option: letting the European Financial Stability Fund (EFSF) take the lead in rescuing troubled euro-zone sovereigns.
“The ECB is the actor that can move very quickly” in a crisis, said Andrew Balls, managing director and head of European portfolio management at bond giant PIMCO, in a recent interview.
The ECB’s balance sheet is just over 2 trillion euros ($2.8 trillion), which makes it a nimbler lender of last resort when markets go awry. In theory, the new bailout fund should eventually supplant the ECB in its bond buying.
But with resources of less than EUR500 billion, the EFSF–created with much fanfare as debt woes in Greece, Ireland and Portugal ignited a continental crisis–has far fewer resources at its disposal to engineer a rescue of Italy’s mammoth $1.8 trillion bond market, if that becomes necessary.
Politics–both internal and external–complicate the ECB’s rescue efforts. Germany, the euro zone’s largest economy and by far the biggest contributor to the fund, remains adamantly opposed to expanding the EFSF.
In Germany, Angela Merkel is coming under increasing political pressure from her own party as it becomes more obvious that Germany will become the backstop of Europe if the EFSF is expanded:
Battle lines are being rapidly drawn up in the German Bundestag for what promises to be a bruising debate over the crisis measures to stabilise debt markets in the eurozone.
Angela Merkel, the chancellor, and her finance minister Wolfgang Schäuble face a revolt among their own supporters in both the Christian Democratic Union and the Free Democratic Party, junior partner in the ruling coalition in Berlin, over the deal they agreed last month with their 16 eurozone partners in Brussels.
The complex political landscape means that Ms Merkel is determined to resist pressure from her partners, and from the European Commission, for any further measures – such as increasing the size of the €440bn European Financial Stability Facility, or introducing eurozone bonds – for fear of losing her parliamentary majority.
Which basically means we are back to where we were months ago but in a worse position. Europe is slowly collapsing, and every path to get out of the crisis now seems to be crumbling.