Tuesday, June 21, 2011

Qu'est Châteaux Eurobolleaux 2011?

Just as in 2010 the Europeans turned to the US for policy guidance and were offered Little Timmy's post crash STFU policy, 2011 sees them turn once again to the US for help with the same reoccurring problem. Now despite what might have been imagined before the implementation of the US QE2 program about 9 months ago, it hasn't been a complete disaster. In fact, if you were a European observer noticing that their stock market goes up, faith and the price of their bonds goes up, their currency starts to drift off making their exports more competitive and they hardly see much of a rise in domestically led inflation, then you might just rub your chin and say. "Hmm, I wonder".

To TMM it looks mightily like the Europeans are dreaming up a cunning new plan. Not as cunning as trimming their toenails with a scythe as the German's tried last year with their banking regulations, but pretty close. For it would appear that just as US QE is coming to an end, the Europeans are going to be embarking on a second attempt of their own version. Far from EVER calling it QE (or even Qu'Est) it will be deftly disguised as European Himalayan pink salt - a fantastic exotic remedy for the Euro woes. Which of course to TMM means a set of generic structures wrapped and presented to the unsuspecting bond holders as a "cure all".

Sharp observers have pointed out at various times over the past 18 months or so that the ECB's LTROs, SMP and balance sheet expansion in general are essentially just an indirect implementation of QE. Banks merely bought their respective governments' paper and promptly delivered it to the ECB's window in exchange for newly-printed Euros. Of course, that only worked until the ECB realised that they essentially had become Europe's "Bad Bank" and were going to take a bath if and when the Club Med eventually restructures. Naturally, the A-Team panicked and embarked upon brinkmanship with the Eurocrats, in the form of threatening to hike rates to force them into action.

And so it seems that the latest offering from the Eurostriches is to increase the EFSF to 780 Gigaeuros from 440 Gigaeuros. But just as Pink Salt is only salt with some pink, expanding the EFSF is just turd with but more turd added. As we know, the EFSF is capitalised such that the bonds it issues are rated AAA, with the proceeds then used to throw good money after bad lending to the iPIGS. Of course, it's not just the Chinese that are buying the EFSF paper, it's also the European banks themselves, because the risk weighting on these bonds is obviously far lower than that of the Greek government. So the banks then deliver the paper to the ECB window in exchange for newly printed paper... which isn't really that different from the ECB's first "no, it's not QE really" QE attempt. Except this time they've tried to get the Eurocrats on the hook for the eventual payout. Now, the thing is, the ECB's balance sheet is about 1.9 Teraeuros, to which TMM reckon we should add the EFSF's size given it all looks like smoke and mirrors to us, meaning that they just magically increased the money supply by about 15%.

And of course, the longer this goes on, the more privately held debt gets paid down, and the bigger proportion of the remaining debt ends up in the hands of EU institutions. The debt may get larger and larger but the scheme can run on happily until:

  1. The guarantor countries can no longer maintain their own credit ratings due to the guarantees they are making to support an AAA vehicle.
  2. The populations of the guarantor nations realise how much they are in hock for and insist on no more.
  3. Someone stops buying the EFSF issues.
  4. EFSF holdings are marked to market and someone realises that the EFSF haircut isn't enough.
  5. The ECB resigns itself to the money supply increase being permanent (Google "Zimbabwe").
At this point TMM want to raise the alarm because:
  1. Embarking on expanding the EFSF is like mainlining financial smack while snorting woonga and smoking crack. Hooked until an early death. There is no escape unless the debt you own turns good and becomes profitable again. Mr Madoff tried exactly the same thing but apparently borrowing new money to repay existing shareholders whilst hoping those Russian railway bonds that paper your downstairs toilet become redeemable for face is called a Ponzi scheme and is illegal.
  2. Mucking around arbitraging credit ratings has only led to two things in the past. Fat bonuses for the inventors and massive suffering for everyone else. TMM await the calls to "mark EFSF paper to market".

Even if the Europeans do get away with pulling off this issuance trick shouldn't the FSA, SEC and other non-European governance bodies ban the purchase of such obviously dangerous products? And if they were too, would then the only money the Europeans could rely on be the Grey funds that arrive in suitcases whose owners expect their money back in full or else horrible things happen?

But of course the really cunning part of all this is that there is no government or central country running this thing. The ECB is still a quasi-governmental body reporting solely to an unelected parliament in Brussels. Who do you actually go to when the poop hits the prop to get your money back?

Now as for that QE. We have already covered how we think this is indirect QE, but in TMM's eyes, it wouldn't be unimaginable for somewhere down this financial maze of collective (i.e - no-one's) responsibility, someone may notice that just buying Greek bonds for the EFSF with money that has electronically been created will be damn site easier than all this AAA issuance guarantee stuff. No-one would either notice or mind really. We mean hey, Qu'Est the harm it did to the USA?


Leftback said...

Nothing like a spot of rémuage and dégorgement, no doubt down in the caves of Château Eurobolleaux™.

Mr Market seems to be inhaling the bubbles already, even before the cork has been popped, TMM.

Japan showing signs of life on auto maker hiring reports, perhaps everyone in Tokyo isn't actually glowing in the dark yet, after all.

Cold Steel™ visiting US equity shorts.

Charles Butler said...

But not the bund longs... yet.

Anonymous said...

Great post.

Anonymous said...

hmm.. unelected? you mean the commission i guess

Polemic said...

err yes sorry ,, the unelected lot ( commisioners). Not the elected lot who run up expense accounts that would make a greek finance minister blush.

Anonymous said...

I knew what you meant. In fact they practically are unelected, at least in the UK. Quel référendum?

Anonymous said...

great post ... and the trade is?

Anonymous said...

As some other poor turd called Richard once said, "now is the winter of our discontent."

Macro Musings said...

How are TMM positioned (or at least directionally inclined) in the euro-dollar, if at all?

Anonymous said...

For me the trade - and I'm deep into it - is short eurusd...

Anonymous said...

short eur seems too easy, especially when the 'QE' at hand is also subsidized via China. That kind of ponzi squared would make even sir Charles blush...

Anonymous said...

If we think it will mimic the effect of QE plus nationalization of the mortgage debt in USA I wonder if short bunds long Italy or some similar play on convergence of risk premia would make sense?

The short eurusd is just as much a trade on 'risk off' generally and doesn't depend solely on the acrobatics of ecb.
Of course I could be way wrong!

Anonymous said...

Great post and good to see you back on the macro stuff.

The fx market may finally get some fear if they sniff out a European qe by stealth.

Qe though seems like a train coming down a hill, once you start and give marginal holders of bonds liquidity to sell into, how do you ever turn It off ?

The bearded illusionist has a massive problem IMO, he's taken out all the longs at the highs and now they are unlikely to help him out on the way down.

It was a much clearer picture before the central bankers all got a turn at the punchbowl themselves

Leftback said...

If China experiences a full-blown credit crunch it will certainly take our minds off Ch. Eurobolleaux:

SHIBOR Increasing

Asian contagion, redux, anyone? It seems like there are any number of catalysts for a stronger dollar out there, including oddly enough, the potential non-appearance of a recession in the US.

The simple pair trade call of the year was probably TMM's Long DMs:Short EMs. Still delivering alpha.

Alen Mattich said...

Can I suggest to the very clever folks at Macro Man that you set up a forum on your home page allowing readers to discuss what's happening in the market even when you haven't been posting?

Clearly, most of the goodness on this site comes from the blog posts, but the readers comments add that je ne sais quoi. A running forum (lightly moderated) run in parallel with the postings might attract even more loyalty.

Leftback said...

We sort of do have a forum, Alen. Claus and LB just bang on here and try to be provocative until someone else comments or TMM lobs up a new post.

Today's action resembles the deep flushing sound that this market needed, especially in the commodity sector. There probably isn't that much wrong with the US economy that a 5% drop in gasoline prices can't help just a little bit. It's like having a temporary tax removed. Obviously, it was kind of BB to tax everyone on behalf of the oil companies and speculative community.

Once energy stocks and financials have received another flogging, we think morale will improve, already feeling a lot more constructive on US equities for Q3.

CV said...

Agreed LB, the post quake lows have not yet been breached and this means the "buy the dip" put is intact. Realistically, in order for the Fed to get really scared we would need a move to below 1250 on the SPY.

At the moment it is all just sideways, volatile yes, but sideways in the end.

I am still long EWJ which also just seems to be poodling along with no direction. But I am constructive for H0211. I am thinking on Dr. Copper as well since with those very, very low SHFE inventories anything less than a completely shutdown in China will see imports getting back on stream.


Anonymous said...

Yeah, after we price a dismal July 1st data release, there will be positive surprise on equity earnings I believe.

All things come back to oil and inflation. Saudi's increasing production plus DM reserve release are all designed to bring down inflation for a few months. Then a stage for more QE will be set up.

Leftback said...

EWJ is well above the post-quake lows and is in the late stages of completing a massive declining wedge. Japanese small caps have bounced back even more strongly. An upward breakout would hardly be surprising, especially if it transpires that Honda and Toyota actually did make a car or two.

In the US, yes, I think that SPX 1250 is a reasonably good floor for this market for the time being. Not sure about the Fed, but a break below 1250 would certainly scare me. As long as GDP print tomorrow exceeds the yield on the 5y, I think Armegeddon will be avoided. At FVX = 1.45%, I'm not too concerned. I don't think this is 2008.

Polemic said...

Alen, re your suggestion ..hmmm - could you email me please?


Anonymous said...

"Chinese Premier declares inflation victory" - ft.com

So risk on for the H2

Anonymous said...

Hans Gruber: I thought I told all of you, I want radio silence until further...
John McClane: Ooooh, I'm very sorry Hans. I didn't get that message. Maybe you should've put it on the bulletin board. I figured since I've waxed Tony and Marco and his friend here, I figured you and Karl and Franco might be a little lonely, so I wanted to give you a call.

Trichet: I thought I told all of you, I want radio silence until further...
Juncker: Ooooh, I'm very sorry Trichet. I didn't get that message. Maybe you should've put it on the bulletin board. I figured since I've waxed Greece and Ireland, I figured portugal and spain might be a little lonely, so I wanted to give you a call.

Tyler said...

Cheers LB. Unfortunately for you...I agree.

Data won't continue to surprise on the downside forever. uptrend is still intact, signs of overly bearish sentiment (despite a modest ~8% pullback), CESIUSD bottoming.

The world is watching 1250 and everybody gets scared beneath those levels. Recall last year around this time everybody was watching 1050 and there was a washout/bear trap. A similar type of move gets you to around 1200. At that point the sky would be falling in the heads of traders and investors.

what say ye, TMM? still looking to short regardless?

Gold looks vulnerable.

WellRed said...

@ Tyler.

Agree on gold, so does silver.

Alen Mattich said...


Apologies for not seeing your note earlier. I've been a little tied up. You'll have to tell me how to email you, because it's not obvious to me (and I'm the sort of person who needs very, very obvious.)

Alternatively you can email me. First name dot surname at dowjones dot com.