Friday, July 08, 2011
Yesterday, TMM ventured forth into the world of BTPs on a macro argument. Today the world has decided that TMM's position has a similarly unfortunate target-shaped birthmark to Gary Larson's deer in his cartoon "Bummer of a Birthmark Hal". We are beginning to hate this week. As you know, we really really really think that Europe is in a mess, but, and here's the big BUT, we don't see it falling just on a market whim.
The massed market armies have been on a crusade against Greece for the past 3 months and had reached the gates of Athens when they were repulsed by the Greek vote and the Euro package (however dodgy). But this has left the screaming attack mob somewhat frustrated and desperate for blood, so they appear to have instead turned their attention to snooping out and attacking anything vaguely euro-weak. TMM's IB chats and mail boxes are full of Euro negatives, many recycled old themes that are being dug up and recycled, but today's favourite lynch victim is Italy. The speculative hoards are crossing the Alps Hannibal-esque in order to give the Latins a good kicking. But like any good army General leading a campaign we need to keep our troops under control for an organised assault and pick when and where we wish to fight our battles. For TMM the battle for Italy is being engaged too soon against a well organised defence and so we are calling for a retreat.
First, for overlying strategy TMM believe that for Italy to get into real trouble EVERYTHING has to go wrong, whereas for Spain NOT to get into trouble EVERYTHING has to go right... So Spain before Italy PLEASE.
Now, let's look at what Italy has lined against the baying hoards:
- The A-Team is focused on the firewall between Spain and Portugal/Ireland/Greece. And Spain is ahead of the queue from Italy so they definitely won't let Italy go.
- The Risk premium priced into Italy is now enormous relative to a macro model ...fair value is 120bps over, currently 240bps. At just 36bps below Spain, that's just rubbish.
- People getting all worried about domestics not turning up to buy... they have no choice, they will turn up.
- Italy runs a current account of only just above 3% and did not do fiscal stimulus in the recession. The starting base is better.
- Today's IP number implies +1.7% qoq in Q2, or an annualised 7% print which is quite strong. People seem getting all beared up on the recent economic data, but it's just shockwaves from the Japan IP drop.
- Open Interest in BTP futures has increased 14% over the past 3days, with today's shenanigans likely to post a further 5% increase ... Tourist Traders (i.e. - non-experts that are bussed in for the mugging) have put on sizable shorts.
- Looking at articles from the Economist re: Tremonti results in a biased view given their public vendetta against Berletchsconi and Co.
- BTPs yielding 5.3% vs. the ECB refinancing rate at 1.5% will have carry monkeys scratching their brows and thinking "hold on, I can make 11.4% leveraged 3x".
- And finally, readers will recall TMM's attempt to price DEM/ITL NDFs with their creation of the END Market. TMM thought it was time for an update, and the 5yr synthetic NDF is implying DEM/ITL at 1000.49 (see chart below), which is -1.06% depreciation. Now, according to TMM's REER models, the Italian Lira is only around 12% overvalued, but accept that under a Euro break up DEM/ITL probably moves 20%. So that implies around a 5.3% (=1.06/20) probability of Italy leaving the Euro. That seems ludicrously too high to TMM. All back of the envelope stuff, but you get the idea.
So come on guys, leave Italy alone. We'll come back and revisit it if Spain goes.