Europe braces for long winter

Well it looks like Santa finally stuck his head out of the dark cave for a look around. It is yet to be seen if he rams it straight back in again because he doesn’t like the weather, but at least he has appeared for one night.

In Europe Santa has come in the form of the ECB’s LTRO (Long Term Refinancing Operation):

Italian and Spanish bonds extended their recent rally on Tuesday as optimism grew that banks would borrow large amounts of cheap cash at the European Central Bank’s three-year tender and reinvest it in higher-yielding euro zone debt. Spanish 10-year bond yields fell for an eighth straight session to hit their lowest in more than two months while slowing investor demand for safe-haven German debt pushed Bund futures down by a full point.

“(This) is led by the excitement about the upcoming ECB tender… in this thin market without any supply to take down this obviously gives the periphery some real tailwinds,” said David Schnautz, strategist at Commerzbank in London. Momentum has grown behind the view that investors would return to support peripheral debt thanks to an attractive carry trade made possible by the ECB, whereby banks borrow cheaply at the central bank to invest in bonds with a much higher return.

A sharp fall in one-week borrowing from the ECB and high demand for one-day loans on Tuesday supported the view that
banks were freeing up collateral to bid for three-year loans at Wednesday’s tender.

As I discussed last week I expect the LTRO to give a short term boost to sovereigns because it may lead to banks purchasing more short and medium termed debt of their national sovereign bonds and ride the carry trade between those bonds and the ECB’s new long term repo facility. It is yet to be seen if that is the case because there are substantial risks involved in the process and banks already own a significant amount of government bonds. It may just be that banks end up using the facility to roll-over existing debt rather than using it to actively make new purchases.

Given that many of the European banks are attempting to de-leverage and simply hold higher levels of capital in order to meet their requirements under Basel III this makes sense. However, that doesn’t mean that the new LTRO along with the lower reserve requirements wouldn’t have some flow-on effect to bond markets, I am just not sure it is going to be used at the level and/or for the purpose the bond market seems to be suggesting. There are, however, some rumours out of Italy that suggest otherwise.

We will find out the answer to some of those questions tonight when the banks make a choice between the 7-day, 3-month or 3 year ( with a 12 month exit ) repo facility. A good uptake on the later should provide some support for all markets in the short term, at least until it is established exactly what the banks are doing with the facility.

However, as I also stated last week , this operation does very little for the banks existing lending asset quality. That is governed by the real economy. In the parts of Europe where the sovereigns need the most help this continues to worsen as austerity bites into industrial production and employment and the deflation of previous asset booms continues to take its toll.

We already know that Spain is about to embark on a new austerity push with the PM promising a cut of $16.5 billion out of this year’s government budget while he has already acknowledge that the country is probably in recession and the unemployment rate continues to climb past 22%.

We also saw more of this last night from Italy

Italian industrial orders fell 1.6 percent in October after plunging 8.2 percent in September mainly due to a fall in foreign orders, the official data agency Istat said in a statement on Tuesday.

The seasonally-adjusted data showed that foreign orders were down 2.4 percent while domestic orders fell 1.0 percent. Orders were down 4.8 percent on a 12-month comparison.  The worst-affected sector were machinery, electronics and textile down 13.8 percent, 7.6 percent and 6.3 percent over the year.

The data was another sign that the Italian economy is entering recession as the government struggles to tackle a debilitating debt crisis.

Joining them is Ireland who unfortunately have become the latest country, along with Greece , in which the IMF has had to admitted their “recovery” program is failing to meet expectations.

Europe should consider additional support for Ireland to ensure the success of its 85 billion euros EU-IMF bailout in the face of a deepening euro zone crisis, the International Monetary Fund said on Tuesday.

Europe’s financial woes are jeopardising Ireland’s ambition to escape its bailout straitjacket and return to market funding in 2013 and the IMF suggested a range of options to help the country’s banks and improve its appeal to private investors.

“Deepening strains in the euro area have … increased risks to Ireland’s debt sustainability, so prospects for programme success remain fragile,” the IMF said in its latest report.

The IMF said it and Europe had agreed to a request from Dublin to bring forward disbursements for Ireland to the first quarter of next year from the second half to help reassure investors about its liquidity given current market turbulence.

As I have spoken about numerous times Europe’s problems are in part due to economic imbalance under a single currency. Last night’s data once again proved that point with Germany outperforming.

The economic situation in Germany is good and there is no danger of a recession, Ifo economist Klaus Abberger told Reuters on Tuesday.

He said the construction and retail sectors were doing better while there had been a slight cooling off in manufacturing due to increasingly difficult conditions for exporters.

The Munich-based think tank said on Tuesday its business climate index rose to 107.2 in December from 106.6 in November, the largest monthly increase since February.

“The domestic situation remains quite good,” Abberger said.

“Things are going considerable better in Germany (than in Europe as a whole). Europe will end up getting a mild recession while Germany will be able to disconnect from that somewhat. We don’t see any signs of a recession for Germany at the moment.”

He said German companies had not suffered much from the euro zone sovereign debt crisis.

So maybe Santa will only becoming to certain parts of Europe this year.

In other Euronews:

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  1. You’ll like this one DE. There will be another summit in January! 😛

    However, this time it will focus on (shock horror) unemployment due to the recession in southern memberstates.
    Hopefully Europe will gradually turn it’s attention to the really dangerous aspects of this crisis, the ones that hit families.

    • The key word is “austerity”

      That word means punishment to anybody on fixed incomes or wages.

      To have Ireland “failing to meet IMF expectations” is a lovely way to put the current situation. No fault but those of the Irish people.

    • ..You’ll like this one DE..there will be another summit in Jan…
      Narr,Anon, not repetitive enough..why not convene it at Punxsutawney,Pennsylvania,call it Gobblers Knob,not a wooded hill with a beautiful view…No,just put candles in the windows and wish you could work more like the Germans,n pray for rain…Forget the lack of modern high-ways,built…stage it in a city square…hmmm ,let me see…arr,yes here it is, previously booked as usual under the name “Groundhog Day” ..I’m pretty sure it starts like clockwork with a ‘ready at 5:59 ,alarms at 6.00…and the staged ‘action starts from 7:20 and 30 seconds…it’s a regular..Feb 2nd..or,let me guess,You being a smart man n all n you already know about the Bills..and seen it all before..hey ,ifso please take it easy on me n don’t pull me over,I’ll only order,
      3 cheese burgers ,2 fries,
      2 chocolate shakes,1 coke,
      and some Flapjacks..or is it too early for the flapjacks…anyway for this..I say better to let it all go on it’s track…and not worry about the Train coming the other-way …they’ll swerve
      Shee be right ,mate.
      Cheers JR

  2. From the Telegraph:- “If the sovereign debt plunges, the banks will need more support; and the ECB will take on the risk. Open Europe said encouraging the banks to ‘load up on risky sovereign debt just to keep the eurozone ticking over in the short-term’ could amount to a ‘spectacular own goal’ by the ECB.

    the ECB’s exposure to the PIIGS has now reached €705bn, up from €444bn in early summer.

    And at this rate, as Open Europe says, “it remains unclear how the ECB would cover losses in the event of a sovereign default.”

    The ECB can only absorb so many losses before it has to either ask for more capital from member states or print more money – both of which would be politically impossible and damaging to the ECB’s standing.

    People seem quite optimistic on MB about the outcome for the Euro. My prediction for 2012 – the Euro as a currency goes the way of the dodo.

    • +3 to SGV, RZ and DE’s analysis

      “In the parts of Europe where the sovereigns need the most help this continues to worsen as austerity bites into industrial production and employment and the deflation of previous asset booms continues to take its toll.

      We already know that Spain is about to embark on a new austerity push with the PM promising a cut of $16.5 billion out of this year’s government budget while he has already acknowledge that the country is probably in recession and the unemployment rate continues to climb past 22%.”

      They need to borrow just to pay the interest…and when you are in high 6s or 7s 🙁

  3. Markets all going up and perhaps the bottom is in for gold.

    A new form of money printing which will probably need a Fed bailout eventually.

    Kick that can!

    By way of numerical perspective I saw on TV that the US Ronald Reagan aircraft carrier cost $4bn. This is chump change compared to a $700bn TARP for banks and the numerous other alphabetised ways of feeding the banks. Could have bought a couple of hundred aircraft carriers for that TARP money. Looked at another way the US and Euro national debts are worth negative many thousands of aircraft carrier equivalents.

    I reckon the Western world must be just about broke and this LTRO operation is just shuffling some more problems from banks to taxpayers.

    • Yay ! A new unit of measure the RonnieAC …

      my particular favorite was on some news program where they quoted the weight of something in multiple “Kylie Minogues”

      • ..I’ll take a dozen..”K-Minogues” that is…
        Can you get a sample to me before Xmas,
        I wonder..Zentao Thanx JR

  4. Hey DE,
    So let me get this right…unlimited LTRO is effectively money printing, but getting the banks to do the dirty work and gets Merkel off the hook on currency debasement? Or am I missing something?

    Why wouldn’t they take up this option, what choice do they have? 1% from ECB, or higher rates from markets if they can convince the markets to lend to them.

    Screw long term consequences over excessive sovereign debt exposure, it is next years bonus that is the main concern.

    • You, the insolvent bank take the 1% money, buy Greek or other crap bonds with a huge coupon and collect mucho Euros.

      If there is a haircut coming or even a default, taxpayers have got your back.



      (We signed with our left hands)