Eurozone

Although gold had its largest drop in the last 2 weeks on Friday, (-1.6%), it was 1.3% higher on the week and trading higher this morning.  Many analysts feel that current sovereign, macroeconomic and geopolitical risks are not reflected in gold's price. Friday's news of France's loss of its AAA rating has put the European Financial Stability Facility (EFSF) at risk. The Eurozone economy resembles a large ship sailing in rough seas since France fund's 20% of the EFSF fund and 8 other members were also downgraded. This will almost certainly lead to the EFSF's downgrade which would result in the fund too paying more to borrow as credit costs rise.  There are icebergs lurking in increasingly murky Eurozone waters. The European downgrades were long expected and may have been priced in the markets. The risk of a non orderly Greek default and of contagion in the Eurozone remains and is not priced into markets. It would lead to the euro falling sharply against other fiat currencies and particularly against gold.

After the fairly muted Wellington open, the reaction of the European bond markets to the S&P downgrade will be the next focus of attention. One benefit of the S&P ratings action is that it takes away one source of uncertainty. Given a French downgrade wasn't widely anticipated, market focus on this issue may well be short lived. Related to the European downgrades is the rating of the EFSF, which was also put on credit watch in early December. S&P have commented that they are in the process of evaluating the impact of the sovereign downgrades on the EFSF rating. For the AAA rating to be maintained it would require further commitments from European governments. Remaining in Europe, newswires report that Greek debt talks will resume Wednesday, thus the Greek PSI is likely to remain a focus all week.

Mario Draghi once again mistakes a Solvency issue for one of Liquidity

With Fed officials a laughing stock (both inside and outside the realm of FOMC minutes), Bank of Japan officials ever-watching eyes, and ECB officials in both self-congratulatory (Draghi) and worryingly concerned on downgrades (Nowotny), the world's central bankers appear, if nothing else, convinced that all can be solved with the printing of some paper (and perhaps a measure of harsh words for those naughty spendaholic politicians). The dramatic rise in central bank balance sheets and just-as-dramatic fall in asset quality constraints for collateral are just two of the items that UBS's economist Larry Hatheway considers as he asks (and answers) the critical question of just how safe are central banks. As he sees bloated balance sheets relative to capital and the impact when 'stuff happens', he discusses why the Eurozone is different (no central fiscal authority backstopping it) and notes it is less the fear of large losses interfering with liquidity provision directly but the more massive (and explicit) intrusion of politics into the 'independent' heart of central banking that creates the most angst. While he worries for the end of central bank independence (most specifically in Europe), we remind ourselves of the light veil that exists currently between the two and that the tooth fairy and santa don't have citizen-suppressing printing presses.

It would appear that the German public (and political class to some extent) are beginning to see the European project in the same manner as we described back in July. As the increasing burden of saving the eurozone from its own excess falls on the shoulders of every Tobias, Dirk, and Heike taxpayer in Germany, even industry leaders, such as Wolfgang Rietzle, the CEO of Linde, this weekend according to Reuters, are suggesting a line in the sand has to be drawn and that "if we do not succeed in disciplining countries then Germany needs to exit." This has been very much a view we have held for months, that instead of the periphery limping away one-by-one, the very core of the foundation will simply decide enough is enough or as Reitzle notes (among many other critically insightful comments) "the willingness of countries to reform themselves is abating if, in the end, the European Central Bank steps in." This morning Germany's FinMin Schaeuble added to the potential separation rhetoric with his comments, via Bloomberg:

• *SCHAUEBLE SAYS ECB AS LENDER OF LAST RESORT WOULDN'T CALM MKTS
• *SCHAEUBLE SAYS JOINT EURO REGION BOND SALES NOT A SOLUTION

Hardly reassuring given the dreams of every GGB owner and BTP-exposed insurance company are banking on the ECB cranking the presses to 'secure' nominal returns in the real world. Friday's mass downgrade (and S&P's more interesting Q&A) have perhaps left Germany on the hook for up to 56% of its GDP via the EFSF support mechanisms and as we noted six months ago, the moment for Atlas to shrug draws closer with every downgrade and SMP action.

All your questions about the historic European downgrade should be answered after reading the following FAQ. Or so S&P believes. Ironically, it does an admirable job, because the following presentation successfully manages to negate years of endless lies and propaganda by Europe's incompetent and corrupt klepocrarts, and lays out the true terrifying perspective currently splayed out before the eurozone better than most analyses we have seen to date. Namely that the failed experiment is coming to an end. And since the Eurozone's idiotic foundation was laid out by the same breed of central planning academic wizards who thought that Keynesianism was a great idea (and continue to determine the fate of the world out of their small corner office in the Marriner Eccles building), the imminent downfall of Europe will only precipitate the final unraveling of the shaman "economic" religion that has taken the world to the brink of utter financial collapse and, gradually, world war.

There is a little for everyone in Marc Faber's latest appearance on CNBC. The infamous boomer (and doomer) believes (as we do) that today's downgrades are less significant for stocks (at least until the realization that banks and more importantly insurance companies are about to be cut as well - keep a close eye out on Allianz and Generali (of ASSGEN fame) - it is not incidental that they are abbreviated to A&G, just one letter away from our own AIG) as it is largely priced in but the equity market's rally of the last few weeks (with its lack of breadth and volume) is strongly suggestive of a bear-market rally (as opposed to the decoupling bull market that so many hope for). His view quite simply is that the ECB has undergone a backdoor monetization and without this the EUR would be significantly stronger especially given the huge short-interest (though he sees the trend for EUR is down).  Some highlights include: EUR weakness may help exports but the debt servicing costs of major European firms with huge US denominated debt wil suffer greatly, most European nations should be CCC-rated, nominally European stocks will outperform and holding quality dividend paying companies is preferred, valuation is practically impossible given ZIRP, and finally noting the irony, the worse the global economy gets (and the Chinese economy suffers), the more money printing will occur lifting nominal equity prices while real economies stumble and standards of living drop, so hold gold.

Today's worst kept secret just hit the wires, as S&P announces that it has officially downgraded France

• FRANCE CUT TO AA+ FROM AAA BY S&P, OUTLOOK NEGATIVE
• "we believe that there is at least a one-in-three chance that we could lower the  rating further in 2012 or 2013"
• "we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating,"

One notch, but the negative outlook means a future downgrade is likely.

The last time intermodal traffic dipped to this level, we were in denial about a Recession and the Dow continued to march from 11,500 in January of 2008 all the way to just above 13,000 in May.

Now that a "few good hedge funds" have finally made CDS a credible instrument all over again but trampling all over ISDA putrid, corrupt and meaningless corpse, here is an update of Eurozone CDS.

The one we've all been waiting for:

• Eurozone Sources Say Several Countries May Face Imminent Downgrade By S&P -Dow Jones
• Eurozone source says Germany will not be downgraded - RTRS... So France will be?
• S&P declines to comment

Ladies and gents -happy Friday the 13th - the French downgrade is nigh. The only question - one or two notches. EURUSD promptly sliding on the news

European Indices are trading up at the midpoint of the session following strong performance from financials, however, Italian bond auction results dampened this effect after failing to replicate the success of the Spanish bond auction yesterday with relatively lacklustre demand. There has been market talk that this lull in demand for Italian bonds is due to technical error preventing some participants from bidding in the auction, but this still remains unconfirmed. Heading into the North American open, fixed income futures are still trading higher on the day having seen the Bund touch on a fresh session high and with peripheral 10-year government bond yield spreads widening ahead of the treasury pit open. Markets now anticipate the release of US trade balance figures and The University of Michigan confidence report.

• China’s Forex Reserves Drop for First Quarter Since 1998 (Bloomberg) - explains the sell off in USTs in the Custody Account
• Greek Euro Exit Weighed By German Lawmakers, Seen as Manageable (Bloomberg)
• Greek bondholders say time running out (FT)
• Housing policy to continue (China Daily)
• Switzerland’s Central Bank Returns to Profit (Reuters)
• US sanctions Chinese oil trader (FT)
• Obama Starts Clock for Congress to Vote on Raising Federal Debt Ceiling (Bloomberg)
• Turkey defiant on Iran sanctions (FT)
• ECB’s Draghi Says Weapons Working in Debt Crisis (Bloomberg)
• Greece to pass law that could force creditors in bond swap (Reuters)

All you need to read.

Are the markets already front running a potential announcement of a third round of Quantitative Easing (QE 3)?   Maybe so.  We had expected QE3 at the end of last summer as the economy weakened substantially from the impact of the Japanese earthquake/debt ceiling debate/Eurozone crisis trifecta.  However, with political pressures running high due to the raging battle in Congress raising the debt ceiling there was little support from the public for further intervention.  Furthermore, with inflation, as measured by CPI, already outside of the Fed's comfort zone, the Fed opted to institute "Operation Twist" (O.T.) instead. With the Euro-Crisis on the broiler, another debt ceiling debate approaching, the U.S. economy struggling along as Europe slips into a recession and corporate earnings being revised down there are plenty of reasons for stocks to decline in price.  Yet, they have continued to inch up.  With short interest on stocks having plunged in recent weeks it certainly sounds like the markets are betting on something happening and soon.