On The Irish Bailout: Sequels Are Always A Bust
From Nic Lenoir
This is certainly true of most classic movies, and it applies quite well to shock and awe emergency/extraordinary economic or monetary policies. Indeed it has so far been true of QE 2.0, and we are finding out for now this could also be true of PIIGS bailout. The initial reaction overnight was a jump in equities and commodities, but is has so far proven to be short lived as the 1,204/1,212 resistance in S&P has held and the same is true for the 1,365/1,367 resistance in Gold. In S&P in fact we are on support around 1,187/1,187 and below 1,184 it is pretty bearish for the near term.
Part of the reaction is completely natural. Bailing out Greece was a first within the EU and perceived as a sign of dedication to fighting the crisis by European institutions it squeezed out weak shorts and profit takers in PIIGS bonds. However the second time around the surprise effect is lost, and if anything it raises the questions as to how many countries really bailed out, is austerity working (Ireland was one of the first to adopt measures), and how many can Europe reasonably bail out before the euro currency's existence is put in question and the richer countries simply throw in the towel on helping their poorer neighbors in an attempt to save themselves. As of now it appears the worries are dominating euphoria.
Also worth noting is the fact Moody's rained on the parade threatening on further downgrades while the opposition in Ireland is calling for elections after the budget. The opposition is very much in favor of throwing the towel and restructuring debt rather than entertaining any form of bail out. Oppositions in many PIIGS country are going to play a key role. Remember that in Greece the problems started when the newly elected government decided to come clean about the country's books right upon assuming power in order not to be held responsible down the road. That is a recurrent risk for all other countries in the Eurozone struggling with their public finances, and the other risk is opposition parties running populist campaign telling people they do not have to take the pain of austerity and they might just default instead. After all Russia was in better shape in 2007 than it was in 1997 one year before defaulting. One could easily argue that it is for completely unrelated reasons (commodities bull market is the key factor obviously) but logic is not a consideration that will keep populist politicians eager to assume power sleepless.
Therefore until the resistances mentioned above in gold and S&P are taken out and PIIGS spreads start compressing (they have retraced the initial tightening by now) the bailout agreement for Ireland is to be viewed as a failure, at least from the market's perspective. From my perspective it is bound to fail anyways but you know that already!
In US fixed income, I am not sure the 2Y auction will be very attractive simply because the curve is quite steep, however 5Y yields have backed up 50bps since the lows, and 5Y and 7Y are just about the average duration the Fed has pledged to purchase. As such, while the 5Y future chart attached makes me think we have one last dip in the cards, I tend to think it is the last for now, and tomorrow or Wednesday's auctions could well mark the lows in US fixed income (high in yields) for now. With Thanksgiving weekend coming up, what could more fun than a weak auction today to get the remaining longs to bail and the shorts excited just before a nice short squeeze as real money steps in tomorrow and Wednesday?
Good luck trading,