Monday, May 10, 2010

The Nuclear Option

If you went home happy and risked-up on Friday, you've probably seen a mushroom cloud rising over the ashes of your erstwhile-profitable portfolio, as the Europeans have engaged the nuclear option in response to the current crisis.

While the sums involved are not quite a match for those used by US authorities last year, they nevertheless reside in the same neighbourhood (assuming they can be fully deployed); the zillion dollar question is whether they'll have a similar impact.

How shall I help thee? Let me count the ways:

* €60 billion in cash from the European Commission, funded by bond sales
* €440 billion in loan guarantees, via pooled support of member governments
* Up to €220 billion from the IMF
* Outright bond purchases from the ECB, to be sterilized (this has evidently already started)
* 3m and 6m full-allotment LTROs
* Reactivation of FX swap lines

As always when it comes to Europe, Macro Man has to bite back scepticism. In this case, he finds himself switching from "show me the money!" to "wow, that's big...who's payin'?" with remarkable ease.

That is, of course, a degree. But the remarkable ability of this situation to look hideous from every angle simply highlights the fundamental flaws in the Eurozone project (i.e., allowing any old country in, regardless of competitiveness, and the lack of a harmoinzed fiscal stance.)

Nonetheless, the immediate requirement for funding from European governments is not particularly high, which is probably a good thing given the spanking the CDU received in NRW over the weekend.

(One is also left to wonder how much a country like, oh, the US will be asked to contribute to IMF aid to Europe, and how well that will go down in a country with a gargantuan budget deficit and mid-term elections rapidly approaching. But I digress....)

Unsurprisingly, all of this has brought about another 180 degree turn in market sentiment, and everything that was cratering at the end of last week is doing its best Superman impression (up, up and away...)

That's a cheeky 6% in Eurostoxx...
...and FX swap points have come back...though not all the way.
It is certainly tempting to point at the bounce off the market low of last March and extrapolate forwards, given that Europe has unveiled its version of QE and bailouts. And in the near term, there is no telling how far stuff can run.

As always in the Eurozone, conditionality and enforcement are paramount issues that will be tricky to solve. No doubt Portugal, Spain, et al. will say the right things and appear to toe the line...but what happens when growth undershoots and so do fiscal revenues? Which will give standards for civil servants, or fiscal rectitude? (This, as an aside, is the primary argument for IMF involvement: so the German's won't have to play "bad cop.")

So what we're left with is that a financial firestorm with its genesis in private sector off balance sheet SPVs is being solved at the sovereign level with a limited-funding SPV to guarantee to the periphery. Niiiiceeee....

In the meanwhile, as risk asset and euro shorts lick their wounds, there would appear to be one trade that makes loads of sense: short Schatz. The Germans will be on the hook for quite a bit of whatever cash is required, and with Schatz yields still under 0.70% it makes a whole lotta sense to fund early and often.

Sadly, Macro Man has a visit to the dentist this morning, so euro and equity shorts won't be the only ones in pain......


The Fundamentalist said...

ECB, like the Fed, has become the financier of last resort.

The Fundamentalist said...

European Monetization Begins: Sources Report Central Banks Have Started Buying Government Bonds

Miss Christian said...

Guess the ECB does not want to make the same mistakes that the FED and U.S. State did with the first TARP money. Perhaps 420bn had been enough, but so that no one should dare "game" the system they added 150bn, and to make sure that people would really shut up they added another 150bn on top. Heavy to be a short seller now

Tristan said...

THE TRICHET PUT! ha ha..... Wasnt it Trichet who said the Euro's stability was based on the fact the ECB wont compromise with the treasuries of EU member states, unlike the US? So much for that!!!!!!

Richard said...

Holding back the years
Chance for me to escape from all I've known
Holding back the tears
Cause nothing here has grown
I've wasted all my tears
Wasted all those years
And nothing had the chance to be good
Nothing ever could yeah

I'll keep holding on
I'll keep holding on
I'll keep holding on
I'll keep holding on

Richard said...

toss up whether ECB/Europe or G Brown uses that first as their anthem ..

David said...

So to be clear - from what we know so far the 'big plan' from the EU is to borrow more money and create a fund to defend the Euro agst speculative attacks from people that think the EU nations borrow to much money ..
Without changing the fundamental issues that got them here in the first place this is just can kicking European style.
Comments from the Germans this morning make it clear that the detail section of this weekend's homework is a tad light.
Sure you have to let the dust settle but this will end up being another reason to sell Europe I fear.

The Fundamentalist said...

U.S. Futures Surge to Daily Limit on European Loan Package.

Buy, Baby, Buy!

Jochum said...

Obv the reason why the US are willing to chip in through the IMF is because it would avoid another round of domestic bank bailouts? EU banks might hold most of PIIGS sovereign debt but the US banks still hold a fair chunk.

Also, reciprocity vis-a-vis the EU backstopping EU banks on their holdings of US subprime paper last year. You scratch my back, etc.

Leftback said...

Bazooka Time. But even Hank Paulson didn't have an unlimited supply of bazookas in his pocket.. we are deep into the crisis when Trichet has to reach into the Bernanke/Paulson bag of tricks.

Hedging our Treasury exposure on Friday turns out to have been a sound move. Finally got the timing right.

Leftback said...

How fitting, almost, that your last day as Macro Man would be a Bazooka Day.

We can only hope that you are still able to put on the cape from time to time and head to the Macro Cave...

Macro Man said...

LB...can you drop me a line with your contact dets at the mrmacro email address? Would be nice to continue to correspond offline....