The most important news of the night is not that the Greek haircut will be 50%, which is still insufficient as it excludes ECB Greek debt holdings, plus as the IMF noted, a 60% NPV haircut on all bonds is needed for Greece to return to viability, but that the EFSF will be just €1 trillion. Unfortunately, the EU Council and its advisor, JPM, refused to read the Zero Hedge analysis on why anything less than €2.4 trillion is insufficient (not to mention assumes no French AAA-downgrade... ever). Which is why we repost it for whatever sentient carbon-based life forms are left to realize why tonight's Euro TARP should be promptly faded until it is at least doubled to well €2 trillion, which, alas is impossible: absent Uncle Sam footing €250 billion solely to bailout French banks, this will not work!
Relentless Equity Outflows Continue: YTD Mutual Funds Redemptions Surpass 2010 Total, Despite Broad Market SqueezeSubmitted by Tyler Durden on 10/26/2011 16:55 -0400
If the purpose of the forced short squeeze between stocks and the EURUSD was supposed to get retail investors back in the rigged casino, it has failed. In the week ended October 19, yet another $3.5 billion in funds was redeemed from domestic equity mutual funds, with all of it and then some once again rotating into fixed income funds, which even despite offering persistently record low yields, continue to be far more attractive to Joe Sixpack than the joke of a centrally planned policy yoyo that has become the US (and global) stock market. And in the meantime, baby boomers who need stable sources of annuities (read: not equities, not even the bubble that is dividend stocks) are not getting any younger. In addition, after this week, the 10th sequential outflow in a row, we have now surpassed $100 billion in outflows from domestic equity funds, and with it the total outflow of all of 2009. With mutual fund cash at all time record lows, or just about 3.4% the smallest tremor in risk assets which forces mutual funds to mark equities to fair value instead of "to short squeeze", will likely set off a liquidation wave unless enough new capital mysteriously appears to fill what will be the equity hole, that will serve as a springboard for even more redemptions and so on in the mutual fund death spiral.
- German Chancellor Merkel said that all models that involve the ECB are not on the agenda tonight, however both leverage models are going to be discussed
- According to a senior EU source, IMF thinks 60% Greek debt write-down is not enough, and it should be 65% or more
- Widening was observed in the Greek/German 10-year government bond yield spread ahead of the EU leaders' summit today
- According to a draft statement from the EU heads of state, banks would need guarantees on liabilities for more direct support for access to funding. It further said that there is broad agreement on requiring banks to have capital ratio of 9%, to be attained by June 30th 2010
- There were reports that the Italian PM Berlusconi may resign
The growing consensus among technical and fundamental analysts is that the stock market has bottomed for the year and is now in full rally mode. There are five basic arguments in favor of a "real thing" rally that runs higher for months to come:
- Stocks almost always rally in November-December, and end in positive territory in the 3rd year of the presidential cycle (2011)
- September data in the U.S. was mildly positive, fears of recession have faded
- Corporations like Google and Catepillar are posting blow-out earnings
- Europe is finally solving its debt crisis in a comprehensive fashion
- China is still growing and thus is still the tugboat pulling the global economy ahead
There are seven factors on the other side of the ledger...
Here is the draft document with our thoughts inserted directly into the document. As more actual details or termsheets become available we will attempt to analyze them as well.
We are getting closer and closer to some actual details. Eventually EFSF will be only one or two things. We will see how much or how little outside money gets contributed.
- Strong European corporate earnings results from the likes of BP and Deutsche Bank supported equities
- There was market talk of a potential reserve requirement ratio cut by the PBOC, however no action has materialised so far in the session
- SNB's Hildebrand said that the SNB will defend the CHF floor with full determination and will buy currencies in unlimited quantity if needed
- Italian transport minister said that a collapse of the Italian government is possible. Also, the Italian Northern League leader, Bossi, said a government crisis is possible
- According to summit draft conclusions, Eurozone leaders will call on the ECB for it to continue buying distressed countries’ bonds in the secondary market under current exceptional circumstances
Clearly all "bad" ideas are good again. Enron perfected the Special Purpose Vehicle (SPV) and was a master of off balance sheet guarantees. Guarantees with their own equity as collateral in many cases. SIV's are SPV's with leverage. The kind of "asset" that got Citi in huge trouble and almost took down the bank. SIV's had a special place in CDO hell, but I guess you can't keep a good idea down. Detachable insurance. So the EFSF would sell insurance that would come with a new issue bond but could be detached and sold separately? If that doesn't sound a lot like the evil enemy "CDS" than I don't know what does. The biggest detractors of CDS always seem to say it is like buying fire insurance on your neighbor's house. U never agreed with that analogy but this is definitely like buying fire insurance on a house that doesn't cover you in event of fire. The details will be interesting but they had better do as much with cash up front as possible because and ability to require cash in times of stress creates the contagion death spiral they are allegedly trying to prevent. Clearly everyone "gets it" now. What "it" is and how much damage "getting it" will cause remains to be seen.
The outgoing ECB president has just released an extremely long-winded speech titled "Tomorrow and the day after tomorrow: a vision for Europe" in which he once again makes the simple case that without someone paying for the European experiment (ahem Germany), and without a Finance Ministry being created (read fiscal union), there is not much future to the creature known as the EMU (and parodied earlier). To wit: "This European finance ministry would, first, oversee the surveillance of both fiscal policies and competitiveness policies, and when necessary, have responsibility for imposing the “second stage” I just described. Second, the ministry would perform the typical responsibilities of the executive branches regarding the supervision and regulation of the EU financial sector. And third, the ministry would represent the euro area in international financial institutions. Since my Karlspreis address, it seems to me that the case for such an approach has strengthened." He reiterates his call for the United Empire of Europe: "Increasingly, it seems that it is not too bold to consider a European finance ministry, but rather too bold not to consider creating such an institution." Naturally he concludes: "Exactly how these new institutions would eventually evolve one cannot say." So don't worry about the details (typical Europe) just promptly sign off your independence to those who know better than you what to do (and can afford to pay for what is best for you). Wonderful. Now have fun selling the proposal of abdicating sovereignty to those European countries which are not Germany, with a particular focus on France and Italy.
Growing optimism over the progress in tackling the Eurozone debt crisis together with higher than expected HSBC manufacturing PMI data from China helped risk-appetite in early European trade. In their weekend summit, the Eurozone officials said they planned to use the EFSF to provide partial guarantees to buyers of new Italian and Spanish bonds, while also creating a special purpose vehicle to attract funds from major emerging countries. These developments provided strength to European equities in early trade, however appetite for risk was dented somewhat as the session progressed, weighed upon by lacklustre manufacturing PMI data from the core Eurozone countries, together with uncertainty surrounding the issue of losses incurred by the private sector investors on their Greek debt holdings. The private sector participants seemed to be willing to take upto a 40% haircut, however Eurozone leaders wanted a 50%-60% loss. This resulted in European equities to come off their earlier highs, which in turn supported Bunds, while the Eurozone 10-year government bond yield spreads widened across the board. Moving into the North American open, the economic calendar remains thin, however Chicago Fed report from the US is scheduled for later in the session, and markets will keep a close eye on developments in the Eurozone.
As so often happens, one of the biggest surprises of the recent period of broad economic weakness, has been the American consumer, who always somehow manages to come through (or so the official econometric authorities make us believe) and cross a chasm of economic stagnation with shopping bags full of stuff. But while the "consumer" (or his department of truth proxy) has sourced the US economic dynamo in the past several months as Europe imploded, and thus served as a supporting brace for the latest incarnation of the US decoupling thesis (where not just Europe, but also the economies of Japan and China have been deteriorating rapidly), the reality is that unless European problems are promptly fixed (which they won't be) the last ditch global economic support pillar, the US consumer, is about to roll over, because as Bank of America explains, "heading into the holiday shopping season; most [consumer statistics] measures are no better than they were last year. In fact, many are worse." And in what may be news to JP Morgan, "With home prices continuing to decline, a wealth driven consumption binge looks unlikely." In other words, while for now the bottom had managed not to fall off the global economy as the tapped out US consumer spent their last dollar to avoid a worldwide re-depression, if European problems are not rapidly resolved, and by that we mean well before the Thanksgiving sales begin, not even "record" corporate profits (which incidentally are rolling over and are purely at the expense of consumption capacity), will do much to prevent the market from finally catching up to reality.
The math of the European bailout (using the EFSF or otherwise) is so easy even a cave-EUReaucrat can do it: It doesn't work. But leave it to Europe's financial ministers to figure this out in the literally last minute. As Bloomberg reports, "A 10-hour meeting in Brussels failed to yield a blueprint for banks’ role in a revamped Greek rescue as European finance ministers haggled over what they called a “credible firewall” against fallout from deeper writedowns." And now it's 5 start dinner time: "The ministers’ meeting broke up at about 7 p.m. after reaching agreement that European banks may need about 100 billion euros ($139 billion) in capital after marking their sovereign-debt holdings to market values, according to a person familiar with the discussions. This amount is needed to reach a core tier 1 capital level of 9 percent based on a European Banking Authority test, said the person, who declined to be identified because discussions are private." No, it's not, it's a joke. The number, once again for those who dare to approach "stuff" mathematically is anywhere between €400 billion and €1 trillion. But we give the EUReaucrats another 2 months before they comprehend this simple fact. Which means that tomorrow's summit which was supposed to be the "come to God" meeting which was expected to resolve all of Europe's problems, much to our, and every other non-momo's relentless snickering, will be a complete and total disaster. But fear not: because Europe has another 3 whopping days after that until Summit #2, when everything will be fixed. For realz.
It's time to forget about Europe's headlines for 15 minutes and refresh what is really going on in Europe, and why European leaders are scrambling day to day to come up with a solution to what is ultimately an intractable problem. Technically, the problem, as explained below, is manifested in three distinct symptoms, which exist in a self-referencing feedback loop that amplifies good input signals when times are good, and incremental debt is ample, and vice versa, or become a toxic spiral where one problem is amplified in the other two, when the system is caught in a deflationary spiral, until the entire system is threatened by collapse. The three "problems" are summarized best in a chart by Morgan Stanley's Huw Van Steenis (see below) in what we have dubbed the "Triangle of Terror" - these are i) Bank Solvency, ii) Sovereign Stress, and iii) Bank Funding Stress...Yet the core problem at the very heart of European instability, is nothing more than, you guessed it, excess debt, €1.7 trillion worth of it to be precise: this is how much debt has to be rolled over the next 3 years, and also explains the magical €2 trillion number needed for the EFSF as only something that big can i) backstop the debt roll and ii) insure the needed bank recap, which in reality needs more like €400 billion but that is the topic of a different post. And without the abovementioned support pillars of bank solvency, funding and sovereign stress being address and fixed, in a credible manner and at the same time, this debt will not be able to roll, and effectively lead to systemic European insolvency. And that, in a nutshell, is what the issues facing Europe are. Everything else is headlines, smoke and mirrors.
- The main focus of the market remained on the EU leaders' summit this weekend and next Wednesday, where participants look ahead for further details on the implementation of the EFSF
- News overnight that the EU leaders are considering to increase the lending capacity of the EFSF to USD 1.3trl boosted risk-appetite
- Fitch managing director, Riley, said that the rating agency has no plans to downgrade France, and the upcoming EU summit outcome is unlikely to trigger review of the Italian and Spanish ratings
- ECB's Nowotny said that the ECB discussed cutting interest rate in its last meeting. Also, IFO’s economist Abberger said that the ECB will likely cut interest rate towards 1%, however the timeframe is unclear
- According to German government sources, Eurozone members could tap IMF credit lines without the EFSF involvement