Who will blink in Europe’s game of chicken?

It isn’t going too well is it ?

Last night Spain sold 3.563 billion euros in 10 yr bonds at a bid to cover 1.54  with an average yield 6.975% . France offered 6 billion euros worth with various maturities. They will pay an average yield of 1.85pc on €950m of new bonds maturing in 2013, up from 1.31pc, €1.069bn in bonds maturing in 2015 at 2.44pc, up from 1.96pc in October, and €3.3bn maturing in July 2016 is up to 2.82pc from 2.31pc.

Equities were unhappy with the result and fell while CDS on both countries pipped up.

Although Italy wasn’t in the market last night it wasn’t spared the bad news as Fitch ratings re-iterated that the country was on negative watch:

“Italy is likely already in recession and the downturn in activity across the euro zone has rendered the task of the new government much more difficult,” the ratings agency said in a statement.

Fitch, which downgraded Italy to A+ from AA- with a negative outlook last month, warned it would cut the country’s ratings to the low investment grade category if it were unable to borrow at sustainable rates on the markets.

“Sustaining political and public support for structural reforms and austerity will be challenging in the face of rising unemployment. Convincing investors that the reforms will be effectively implemented and will boost economic growth over the medium term will be equally if not more challenging,” it added.

“In the event that the Italian government loses market access — not Fitch’s base case — the ratings would be lowered, likely to the low investment grade category.”

As I said yesterday, once the the contagion starts lapping at France then expect the screaming for ECB to get louder. We are now seeing that playing out:

German Chancellor Angela Merkel rejected French calls to deploy the European Central Bank as a crisis backstop, defying global leaders and investors calling for more urgent action to halt the turmoil.

As the crisis sent borrowing costs in core economies outside Germany to euro-era records, Merkel listed using the ECB as lender of last resort alongside joint euro-area bonds and a “snappy debt cut” as proposals that won’t work.

“I’m convinced that none of these approaches, if applied right now, would bring about a solution of this crisis,” Merkel said in a speech in Berlin today. “If politicians believe the ECB can solve the problem of the euro’s weakness, then they’re trying to convince themselves of something that won’t happen.”

Up until this point, the ECB has resisted calls for greater action. The ECB has one clear mandate and that is price stability. It has never had a mandate for fiscal policy either of a single nation or at a supra-european level and under European treaties fiscal operations are the domain of elected governments. The ECB’s stance on this is that they should go no further because it is the responsibility of individual countries to make decisions on fiscal policy. i.e, if the European governments want to help each other out then they have the power to do it themselves via transfers, the ECB does not need to play any part in that.

Obviously the issue is that at this stage their is not the political will for that to occur. The Germans have hinted a number of times that they are willing to move towards a more unified Europe but that will require nations to give up some of their sovereignty. I mentioned earlier in the week that I thought Germany was preparing for this in allowing Eurozone members to leave if they wanted to. Angela Merkel also re-iterated her position on this yesterday as she visited Ireland claiming that her own country would be “prepared to give up a piece of national sovereignty” over its budget. The Irish PM, however, didn’t seem happy with the idea.

Given that the French are levelling up the rhetoric about the use of the ECB suggests they aren’t on-board with the plan either. This certainly isn’t the first time Germany and France have disagreed on how to re-balance Europe, back in early 2010 the then French finance minister, Christine Lagarde, made it pretty clear what she thought the problem was:

“(Could) those with surpluses do a little something? It takes two to tango,” she told the Financial Times newspaper. “Clearly Germany has done an awfully good job in the last 10 years or so, improving competitiveness, putting very high pressure on its labour costs.”

Though Germany recently lost its crown as the world’s leading export nation to China, Europe’s largest economy still has a positive trade balance with most of its immediate neighbours. And eurozone members can no longer devalue their currencies to compensate for Germany’s surplus as they frequently did before the introduction of the euro.

“I’m not sure it is a sustainable model for the long term and for the whole of the group,” she said. “Clearly we need better convergence.”

But Chancellor Angela Merkel’s spokesman on Monday refuted Germany was the problem.

“We are not a country that sets salaries or consumption by decree,” he said. “It is better to think about a growth strategy together rather than obliging some to hold back artificially.”

I will ignore the irony of the now IMF head making disparaging remarks about Germany’s trade surplus, but it does highlight the historical context around the current disagreement.

The French see Germany’s economic model as part of the problem but can do nothing about it and are therefore demanding ECB action, the ECB believes it is the national governments issue to work out between them and is resisting while Germany thinks that it has a plan for resolution but France, along with many other parts of Europe, don’t appear to like it.

Something has to give. Who will blink first?

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  1. Even with greater EU integration, and if the new union forced the ECB to print, there are many years of pain left; also QE’ing is not going to help IMO should they go down this path. The bond market have lost confidence, USD liquidity is freezing/frozen, and the so called Bazooka II is unlikely to get off the ground.

    Where is the growth and job creation coming from to help exit the crisis?

    • +1. In addition, Merkel just said that she does not believe that printing right now would solve anything. It makes perfect sense.
      It looks like some banks will fail and get nationalised and once there is some prospect of starting from a cleaner table, maybe then she’d agree to turn on the printing press in order to stimulate growth.

  2. monetze the debt is the ONLY option. they will work this out soon enough.

    back to important issues though, did anyone notice the intial claims and housing starts data out of the US last night?

      • no not yet, but you wont see significant market falls into a genuine US economic recovery.

        buy the dips sherlock, buy the dips.

        • GB, I’m not sure you are right this time. The chance of the ECB printing is probably not as high as you think. While I think that it will happen eventually, things will be bad by then.. so a 20% rally after a 30% drop won’t be a good investment.

          Buying dips is a good strategy but you only need to buy one leap over the cliff to ruin you.

          • buy the dips is abull market strtegy. if you dont think we are ina bull market dont implement it. i think we are

          • What type of bull market is the question GB – a new secular bull market (i.e XJO to 8,000-10,000 by end of decade) or a cyclical bull market within a secular bear market (e.g 1974-1976 All Ords, 1998-2000 Nikkei 225).

            Macro conditions will provide the best indication of what type of market we are most likely in and from that probability and your investment timeframe (weeks, months, years or a decade or two) determines your risk management and asset allocation.

            If this was an out and out secular bull market and you had a decade up your sleeve, and the worst case scenario is we are replicating the post 1987 bust (which took 7 years to return back to nominal level), then sure, buy the dips. Leverage up and buy high dividend yielding stocks, sit back and wait. High volatility, but low risk if you don’t sell your paper losses (or get a margin call, so less than 30% LVR is prudent – I’d use instalment warrants instead and have the high dividends

            But it ain’t. It ain’t by a long shot a secular bull market – about a 5% chance that it is – and a 50/50 chance this is a bear market rally up to say 5000 points or so, but only on the back of QE3 or ECBQE1.

            The telling probability is there is more than 50% chance this is a secular bear market, where we might see the nominal high of 6700 on the ASX200 reached sometime in 2017-2020. That’s the “best case” scenario, IMO (about a 5-7% average annual return). Value traps will abound throughout – “cheap” assets will be cheap for a reason, and stock picking – not just slavish index riding – will be paramount.

            Saying “buy the dips” without explaining and weighing up the above probabilities is careless and lazy investing in the current environment.

          • prince appreciate the post. “But it ain’t” you dont know that anymore than i know it is. you have your veiw and i have mine and we will see who is right, thats what makes a market.

            “Saying “buy the dips” without explaining and weighing up the above probabilities is careless and lazy investing in the current environment.” its not lazy ive gone over my reasoning about 100 times here already since i said in september that the market bottomed. I can’t go over it and repeat it everyday. persoanlly i think telling people to stay in cash when stocks are clearly cheap on any valuation metric and the worlds largest most important economy is recovering is careless.

          • GB, you were posting a few days ago that the XJO had gone through 4300 and it wasn’t coming back this time.

            Its below 4200 now.

            Yes the US is looking better than expected a few months ago, but Europe is still a God-awful mess and that will continue to hang over the equity markets. Meanwhile the credit markets are screaming disaster ahead.

            What matters most to us in Australia is whether the Chinese construction mania continues. If it does, or they reboot it with another round of stimulus, then I think the ASX will rally strongly on that, but not while China still has its foot on the brake.

          • yes lorax, i did say that and i was wrong. happy to admit it. but i still reckon it will prove to be right. if its not right im buggered and my whole veiw on the market is wrong. if that happens ill also be happy to admit it. actually, I wont be happy but i will still admit it

          • @GB:

            “telling people to stay in cash when stocks are clearly cheap on any valuation metric”

            >20x cyclically adjusted PE is NOT cheap. There’s a valuation metric for you.

            IMO we are coming off a secular high in corporate profits, profit share and productivity.

            The one point I do agree on is the relatively positive developments in the US economy. Unfortunately it’s not going to translate into jobs for a while. That economy is still built on a 2007 demand level capacity, and those levels of demand just ain’t going to be there for some time.

          • yes well aware of this been watching it for years. looks like they have formed a nice base at histocically low levels and are now moving up? is that what you see?

          • I’m not sure where this is going to go. Banks are loaded up to the eyeballs with foreclosed homes waiting to be unloaded. If the market did pick up, they would quickly try and dump them.

            I guess the main thing we differ on though is that I think we are approaching a dead bear falling of a cliff market. Or this: http://www.themostawesomepageintheuniverse.com/wp-content/uploads/2009/08/bear-cavalry.jpg

            Anyway, there is nothing the EU can do. We don’t even hear anything about the EFSF anymore. No plans for plans. Germany is busy trying to prevent the ECB printing. People don’t realise the mess this would create. Like Negative gearing, once you start you can’t stop without creating a crisis, all the while slowly building up to a bigger one. At least with a massive global writedown, money would still have value…

          • My NY banker mate says, in his opinion “there will be no real US recovery until housing recovers”. He also said with housing at an all time low, people can’t afford to buy. That from the point of not having the cash to higher credit requirements, to risk that the bank accepts.

          • a63, hopefully all the ‘can’t wait for the housing crash because I’m going to jump in a buy a cheap property’ commenters here at MB read your comment. A reminder that a wholesale housing crash goes hand in hand with a range of long-term damaging effects in the broader economy. A cheap house at any price???

    • Monetizing the debt can keep the insolvent from failing. But it cannot provide a mechanism for the necessary price/competitiveness adjustment processes to occur. The ECB has done a bit of printing, and have kept the system intact (just), but the system is still cactus. It just doesn’t work.

      Because it doesn’t work, and because the debt bubble is unsupportable, contraction is unavoidable. The contraction cycle now underway – far from leading to growth – will only lead to further contraction. That is, the Europeans have decided it is better to throttle themselves because it is easier than re-making their system.

      Regarding the US, their steady-state is still intact – very slow growth, which is much better than none at all.

          • There is some positive signs in the US, but until we’re seen some more data over a few more months I’m staying out, but I’m generally positive that this will be one of the best opportunities in my life to make some real money in the markets. However, I sold out in March and did very well for the previous 12 months. I’m not going to risk my capital yet, but in some sectors I’ll be back in soon in a small way. I’m seriously cautious for now.

          • Sorry dude! Just an observation. I did not mean to cause offence.
            I don’t have a go at traders, mock people for their investment decisions, etc. Not what I was doing.
            Merely pointing out that in the same para you said:
            1) Things are looking up in the US
            2) this will be one of the best opportunities in my life to make some real money
            3) I’m not going to risk my capital
            4) I’m seriously cautious.
            Sounds confused to me.

          • No worries. To clarify I see the world economy recovering eventually, and if you look back in history at previous recessions, you can see the entry and the exit of these events. I’m looking at where we are in that cycle, and will start to average back into the market as you can never pick the bottom. I sold out in March as it was three months before the end of US QE2 and thought we’d see extreme volatility – I don’t day trade so I wanted to take my profit and then see what happened. All my stocks were well up in March so I hit the sell button. If I’d stayed in until June I would have done better, but the timing was good enough.

            Given EU is a mess, and US is as well, but they showing some positive signs, but it’s too early IMO to see if that continues. Given the US and EU are China biggest trading partners any slowdown in the EU will effect China and the US as far as I can see. So just when we’ll see sustained recovery I don’t know, but when we do that when I think it will be great for equities. I don’t claim to have the answers, but I’m looking to the past to learn about how this could play out. So far it’s worked for me.

    • I am not sure that they will monetize much of the debt by printing. Doing so is essentially kicking the can further down the road.
      It wouldn’t be a real solution, as it would in all likelihood reduce the pressure needed to implement real structural reforms. i.e. it would just be business as usual, with no lessons learnt.

      I think much of the volatility in global markets is due to the fact that the US
      essentially has negative real interest rates. This encourages speculation and the computer trading systems only amplify the volatility as they just follow each other.
      If ECB don’t print and instead the countries implement reforms and actually pay back their debts (or stick to a policy aimed at doing so), then I guess the UK and the US will comeback into the firing line, as I don’t think anyone truly believes they will ever repay their debts.

  3. Things get confused around here about how to promote real economic activity and how best to make the next fiat money move.

    • Thats a very good article, and I find myself in agreement with everything the Bundesbank president is saying.

  4. GB what planet did you just fly in from? A BULL market? in what? Aside from US treasuries all I see is headline driven algorythmic trading interspersed with general panic. And what do you suppose is going to happen to your ‘bull’ market next week when the ‘Super’committee reports that they can’t agree on any fiscal measures to at least rein in the deficit (ha ha)? The debt is $15t and counting, or are you a Dick Cheney ‘deficits-dont-matter’ fan?