Eurozone

Certainly, if we compare the fiscal trajectory of the Eurozone as a whole with the US, the US is not really on a better path.

Back in December, when noting the first material blow out in PIIGS spreads following the first Greek bailout 6 months earlier, we touched upon Italy, and specifically looked at a way to best play the coming shift in Eurozone contagion from the periphery to the core, coming up with one unique corporate name. Back then we said: "We all know what has happened to Italian bond prices in the past weeks: as of today, Bund spreads have just hit a fresh all time high. But all this is irrelevant since the bank must have a capital buffer to accommodate the losses. After all, what idiot would run a company with almost €300 billion in Euro-facing bond exposure and not factor for deterioration in risk after the events of May... Well the ASSGEN CEO may be just such an idiot. The company's balance sheet as of 9/30 discloses that the firm had a mere €10 billion in tangible capital (excluding €10.7 billion in intangible assets). So let's recap: €262 billion in Euro bonds on.... €10 billion in tangible equity! A 26x leverage on what is promptly becoming the most impaired asset class in the world." In a nutshell, Assecurazioni Generali, one of Italy's largest insurers, is a highly levered windsock for Italian and other PIIGS stress, and better yet, can be played in either equity or CDS. Now that the European bond vigilantes are once again looking beyond Greece and focusing particularly on Italy (especially based on recent Sigma X trading), none other than JP Morgan (which just cut its estimates on GASI.MI, a very appropriate equity ticker) validates the thesis that Generali (or ASSGEN per its memorable corporate/CDS ticker) is the best proxy for contagion: "Generali is one of the most sensitive stocks to both the sovereign debt crisis and the implications for the financial sector through both its government, corporate and equity investment portfolios...Generali’s sovereign exposure is mainly concentrated in Europe with Italy accounting for the largest share (37%; home market bias)."

Markets witnessed risk-averse sentiment in early European trade partly on the back of comments from Moody's that China's local government debt may be USD 540bln larger than auditors estimated, which could endanger Chinese banks' credit ratings. Lower than expected services PMI data from China, and core Eurozone countries dented risk-appetite further, which in turn resulted in weakness in EUR and equities. However, as the session progressed equities gradually came off their earlier lows, and the oil & gas sector received some support after the UK Treasury announced tax support for North Sea oil companies. Elsewhere, GBP/USD gained strength following better than expected services PMI data from the UK. Moving forward, the economic calendar remains thin, however markets look ahead to economic data from the US in the form of durable goods revision and factory orders figures.

Gold is higher today and showing particular strength against the euro and the Japanese yen. The relief rally seen in equities since the latest Greek ‘bailout’ is under pressure as S&P have said the debt rollover proposal would be a “selective default”. The ECB may selectively reject the S&P Greek downgrade and arbitrarily select the best credit rating being offered. Gold has been supported in the traditionally weak “summer doldrums” period due to institutional demand and strong physical demand at the $1,500/oz level, particularly from Asia. Gold tends to take a break in October and then has a second period of seasonal strength from the end of October to the end of December. This has been primarily due to Indian religious festival, store of wealth, demand in the autumn and western jewellery demand prior to Christmas.

The best thing to ever come out of RBS is back in its original format, now that Bob Janjuah has decided to begin releasing Bob's World again, if not with the unique trademarked grammatical style. That alone must be worth 95% of the intangible, and thus all, assets on RBS' balance sheet. To those who read just the first few paragraphs and are left scratching their heads if Bob was lobotomized in recent weeks and now sees nothing but upside, so contrary to his usual cheery disposition, we suggest reading on - that is merely his outlook for the short-term. The long one: "my view beyond July/August is bearish and very much risk-off. In late Q3/Q4 2011 I expect to see the beginnings of a meaningful sell-off in global risk which should take the S&P below 1220 and on its way possibly to the low 1000s. In this risk-off move I would expect – initially at least – USD to rally sharply, with the DXY index closer to 80 than 75, and major DM government yield curves to bull flatten, with 10-year UST yields falling to around 2.5%. Credit spreads should widen, but I expect non-financial corporate credit to outperform in relative terms. Having said that, in this major risk-off phase I still expect the iTraxx Crossover index to rise well above 500. And commodity weakness should be a major part of this late-2011 serious risk-off phase." Ah yes. Good old Bob.

Last Wednesday we cited from a Reuters report, according to which the last ditch Greek MLEC/CDO rescue operation, would be welcome to S&P and Moody's as "The whole charm of the French model is that it was worked out in a such way that it will be fine with the rating agencies." Because absent a decree of no EOD, the whole thing is pointless. Well, as often turns out, this was yet more wishful thinking on behalf of some bureaucrat, masked as fact. S&P has just come out with the following: "In recent weeks, a number of proposals relating to this  topic have surfaced, and the particulars in some cases are evidently still  in flux. This credit comment looks at the most prominent of the recent proposals, put forward by the Fédération Bancaire Française (FBF) on June 24, 2011, in the context of our criteria for evaluating distressed debt exchanges and similar debt restructurings (see Related Research below). In brief, it is our view that each of the two financing options described in the FBF proposal would likely amount to a default under our criteria" and specifically: "we believe that both options represent (i) a "similar restructuring"
(ii) are "distressed" and (iii) offer "less value than the promise of
the original securities" under our criteria. Consequently, if either
option were implemented in its current form, absent other mitigating
information, we would likely view it as constituting a default under our
criteria." Goodbye MLEC 2 - as expected you were just as useless as your first iteration back in 2007.

A week ago, Zero Hedge penned "An MLEC In PIIGS' Clothing: The Latest Greek Bailout Proposal Picks Up Where the Super SIV Failed" in which we explained how the current fatally flawed proposal for a Greek bailout is nothing more than a structured vehicle, expected to remain off the books, and much more importantly, expected to not trigger rating agency ire, and kill the entire extend and pretend game: remember - an Event of Default by a rating agency, even a Technical one (completely irrelevant of what ISDA does with Greek CDS) means game over for the European Central Bank and its €2 trillion in "assets", not to mention the western financial system. Now, a week later, the FT's own Wolfgang Munchau explains why our observation of how toxic the "bailout plan" is was rather accurate: "This structure is still not quite so complex as some of the more elaborate CDOs we have encountered in the global financial crisis. If you take some time to work through the arrows and boxes, you see relatively quickly that this complex structure is not a private sector participation at all. Rather it is a private sector bail-out... I have no space for a large drawing with lots of boxes and arrows to explain the complexity of the vehicle, through which eurozone governments want to involve the private-sector banks in its next loan package." Munchau's conclusion: "If this was any other field of human activity, you would go to jail if you accepted, let alone made such an indecent offer." On the other hand, all is fair in love and perpetuating the ponzi Status Quo^TM. Our follow-on observation that "The two things that are keeping the Eurozone afloat: an SPV and a CDO" alas appears also to be rather in line. And before the entire financial system collapses upon itself like a cheap lawnchair, this will be fondly remembered as one of the more prudent "rescue" mechanisms enacted to delay the inevitable.

In the week ahead, we are waiting for the second batch of key activity data in the form of service sector and non-manufacturing surveys, as well as US payrolls. The Chinese non-manufacturing PMI has already been released over the weekend, showing a decline from 61.9 to 57.0. After last week's key votes in Greece, headline risk should decline though we are now entering the phase where the final negotiations for the second support package take place. The updated funding strategy for Greece will likely be unveiled by Eurozone Finance Ministers on July 11. There will be central bank meetings by the ECB (+25bp), BOE (on hold), in Malaysia (+25bp), Mexico (on hold), and Poland (on hold).

The Greek indigents huffed and puffed, broke a couple of marble plates from Syntagma square, striked for a few days (or is that stroke?), and achieved nothing. In the meantime, their government just sold off the country to European banking interests. But don't take our word for it. Take the word (on those very rare occasions when it is actually telling the truth) of Eurogroup chairman Jean-Claude Juncker who just told Focus magazine that "The sovereignty of Greece will be massively limited." And just like DSK's innocence was effectively granted 2 days after Christine Lagarde was made new head of the IMF (we still are waiting for the IMF to have a statement on the recent DSK developments), so Juncker's stunning disclosure comes not even 12 hours after the 5th Greek bailout package has been released. Per the Guardian: "Juncker's interview appeared just hours after Eurozone ministers signed off the fifth tranche of last year's bailout, worth €12bn. The payment must now be rubber-stamped by the International Monetary Fund (IMF) and pushed through by 15 July in time to meet several bond repayment deadlines. Agreeing the latest IMF payout, on 8 July, will be an early task for Christine Lagarde, the new IMF boss, who starts work in Washington on Wednesday." One wonders how different, it at all, DSK's probanker stance would have been had he still been the IMF head.

The very critical, and very insufficient 5th bailout tranche to Greece, has now been approved. From Reuters: "Euro zone finance ministers agreed on Saturday to disburse a further 12 billion euros to Greece and said the details of a second aid package for Athens would be finalised by mid-September. After a conference call, the 17 euro zone ministers agreed that the fifth tranche of the 110-billion-euro bailout agreed with Greece in May 2010 would be paid by July 15, as long as the IMF's board signs off on the disbursement. The IMF is expected to meet on July 8 to approve it. The payment will allow Greece to avoid the immediate threat of default, but the country still needs a second rescue package, which is also expected to total around 110 billion euros and which will now likely only be finalised in September. Between now and then, finance ministers will work on the "precise modalities and scale" of the private sector's involvement in the second aid package, which Germany hopes will eventually total around 30 billion euros. Greece said it expected a final decision on a second bailout programme by mid-September to keep the country financed. Eurogroup decided through a teleconference today to work out a new programme on time, before mid-September," Greek Finance Minister Evangelos Venizelos said shortly after the finance ministers approved the 12 billion euro disbursement." More importantly, "The 12 billion euro payment will help Athens cover a 5.9 billion euro bond redemption in August, but the government still has a monumental hill to climb if it is to return to debt sustainability, with its debt-to-GDP ratio above 150 percent."

The week's most concise summary of key bullish and bearish events.

The EU vs US - Who Crashes First? Reserve currency status is a very strong lever, historically. Equally important, the holder of said status has usually held the most powerful military and technology as well. Meanwhile, the EU has the twin problem of CRE debt rolling over on underwater properties and devalued (by up to 50%) sovereign debt held at 30x leverage as risk free assets at par by the banking system. True, the US has similar CRE issues + housing depression... So much to contrast & compare.

It was really easy getting that mortgage in Hungary, and the best of all, denominated in Swiss Francs, so the interest rate was low. Such a great plan, if it wasn’t for that currency risk.....

A few days ago, we demonstrated that the latest Greek bailout package is nothing more than recycled MLEC special purpose vehicle designed to cover up toxic assets off balance sheet, like that one that was supposed to wrap up the subprime toxic mess. Luckily that did not happen as all it would do is make the credit crash even more acute when it finally did hit. In the meantime, the other Frankenstein contraption proposed by Wall Street to contain the fallout of the PIIGS bankruptcy, is the EFSF, which also got a facelift a few weeks back, and which is effectively a CDO: the same instrument which caused European banks to now be insolvent after buying up all tranches offered them by Goldman et al in the 2005-2007 period, once US banks realized just how toxic the less than AAA tranches were. It is poetically ironic that the instrument that led to Europe's insolvency is now what is supposed to prevent (temporarily) its plunge into outright default. For all who are wondering what the details of the new and improved CDO at the heart of the Eurozone are, here is Nomura's Nikan Firoozye.

Three months ago, Goldman's Francesco Garzarelli released a note to clients advising them to short the 5 Year as follows: "We recommend going short 5-yr US Treasuries at 1.936% for a potential target of 2.30% and a close below 1.80%." Naturally, our cynical outlook on life prompted us to say the following: "As usual, since that would mean Goldman is now accumulating 5 Year inventory, it appears we will soon have a rather dramatic duel between the two biggest Wall Street titans: PIMCO and Goldman, at least as pertains to their outlook on rates." Well, Goldman won so far (its clients not so much). Today, Goldman is telegraphing that it is starting to accumulate the next batch of 5 years, which makes sense considering the point on the curve experienced its 3rd worst 3-day decline ever as reported yesterday. To wit: "Ahead of key data for June, starting with the June ISM report this Friday, we recommend initiating short positions in 5-yr UST at the current level of 1.70%, for an initial target of 2.00%, and stops on a close below 1.40%." Round two of Goldman vs PIMCO is now on.