Monday, May 23, 2011
And we are off! The roll-over that TMM has been waiting for in their JSTFR plan has arrived. We are fully aware of the TMM Non-Predictions re: Spain over Germany and EUR/CHF but we have plenty of time for all of that. For the moment, however, we are in a rerun of 2010. In fact, looking at the price action you could almost say that nearly to the day "EUR/USD May 2011 = EUR/USD May 2010 + 0.1800". Today's fuel for the fire have been the Spanish elections (following on from Catalonia's revelations last week, debt skeletons are expected to tumble out of regional closets), S+P putting Italy on credit watch negative, European PMIs (yes even you, Germany) and just to keep the risk globally balanced let's chuck in a weak Chinese PMI too. So for Europe, in the words of Queen, "Is this the real life, or is this just fantasy, caught in a landslide, no escape from reality"?
The perceived wisdom (and TMM's view) for the past 6 months or so has been that Spain was fine and de-coupled from the basket cases of Greece, Portugal and Ireland, as the Caja recapitalisation plans were progressing well, growth had returned and the stress tests for Spain were virtually the only ones with any credibility last year. However, this view was predicated on the condition that nothing else went wrong. And, with the combination of hidden debts (bringing back bad memories of Greece), more widespread social unrest and an electoral backlash, all of a sudden this isn't looking quite as clear cut as it was a couple of months ago. Indeed, S&P's weekend downgrade of Italy to Negative Watch underlines the fact that Spain and Italy are breaking out of the trading ranges they have essentially held since last year's bailout (exception a brief period in late November-early January) on the back of real domestic news-flow, rather than on the back of speculator-driven contagion. To TMM, this is an exceptionally important distinction, as it demonstrates that the dam around Spain & Italy is breaching.
TMM fear that all things Euroblx are in the process of becoming systemic once again, as it is clear that the politicians have decided that there will be some form of Greek restructuring imminently, the ECB are panicking at this prospect, and Spain and Italy no longer seem immune. The below chart shows the rolling average correlations of Spain's 10yr Bund spread with the rest of the PIGS (red line), Italy with the rest of the PIGS (blue line), the average PIGS cross-correlation (orange line), and periods of average PIGS spread widening denoted by the green line (TMM's Excel skills are wanting!) during 2010's episode. As can be seen, in the run up to Stress Tests in June 2010, periods of spread widening were accompanied by high or rising correlations between the PIGS, and it was only after that dispersion rose as systemic fears died down.
Looking at a more recent history, in spread widening periods, the cross-correlations tended to fall during spread widening periods as Spain & Italy had been judged to have decoupled from the rest of the pack. However, since mid-April, the opposite appears to have been happening, with spread-widening episodes being accompanied by rising correlations. This argues that the crisis is once again morphing into a systemic one.
So in summary, TMM think we are seeing a general dam breach in some of the levees that the Eurocrats had built and been pinning their hopes on. Acceleration is picking up in the downward S curve in prices in general to move TMM's stance from JSTFR to JFSI.