Sovereigns

When the Eurozone crisis first broke some four years ago, most analysts quickly and correctly concluded that the Eurozone was an incomplete monetary union; but, as UBS Larry Hatheway notes, neither rapid integration nor breakup were or are politically feasible options for Europe’s political classes. The 'Merkel-Draghi wager' then began with the determination that capital markets would not dictate Europe’s future: with growth-supporting fiscal transfers or debt mutualisation ruled out by national politics, the remainder of the story is about an ‘Austrian’ solution to cleanse Europe of excessive fiscal deficits, narrow gaps in competitiveness, and shrink external imbalances. The ‘Merkel-Draghi wager’, then, is a political gamble of historic proportions. It is a calculated bet that a policy prescription of robust liquidity buffers coupled with internal devaluation and fiscal consolidation will work. Equally, it is a view that the historical, cultural, economic, financial and political forces that have brought Europe together in the post-war era will prove stronger than those unleashed by the wrenching social dislocations associated with ‘Austrian’ economics that could one day threaten to rip apart the Eurozone. So far, the ‘wager’ is working in economic terms, or at least that's the hope.

A few days ago, to the surprise of many, the European Parliament voted through substantial curbs on banker pay, limiting bonuses to twice the annual salary (we have yet to see the list of pre-existing loopholes, which we are confident will be wide enough for Arnold's hummer to pass through). Today, in a less surprising, although perhaps more notable development, more than two-thirds of the Swiss people voted through a proposal to curb "fat cat-ism" in Switzerland, and impose strict controls on executive pay, including compensation vetos and payout bans. The development is notable, because unlike other insolvent nations, Switzerland is actually one of the most affluent sovereigns in the world, and class warfare is hardly as much an issue as it is in the US. The fact that Swiss society is as polarized as it was confirmed to be this morning, shows just how deep the rich vs, well, non-rich tensions truly lie, even in the most wealthy of societies. One can then imagine how close to snapping they are in other less well-off places, read most countries, in the world.

When two weeks ago we exposed the heretofore secret location of JPM's London gold vault (located under the firm's massive L-shaped office complex at 60 Victoria Embankment) we thought: what about New York? After all, while London is the legacy financial capital of the "old world", it is in New York that the biggest private wealth of the past century is concentrated, and it is also in New York where the bulk of the hard assets backing the public money of the world's sovereigns are located, some 80 feet below ground level in the fifth sub-basement of the New York Fed, resting on the bedrock of Manhattan. That the topic of the gold "held'' by the New York Fed - historically considered the gold vault with the largest concentration of gold bars in the world - has become rather sensitive, in the aftermath of the Bundesbank's request to repatriate it (surely, but very, very slowly), is an understatement. Yet in the aftermath of some of the revelations presented here, we believe quite a few other countries will follow in Germany's footsteps for one very simple reason: suddenly the question of whether their gold is located at 33 Liberty, or just adjacent to it, in what we have learned is the de facto largest private gold vault in the world, located across the street 90 feet below 1 Chase Manhattan Plaza, doesn't appear to have a clear answer.

A successful entrepeneur's take on the European sitaution...

Today’s big event was Italy's 10% auction. Buyers can’t ignore yield, and we suspect many were “encouraged” to participate. But a decent Italy auction doesn't change the brutal facts. Electoral fall-out blankets the Euro battlefield, but it was decisions made years ago that have brought us to this blasted heath. Markets are caught in... Stalemate. On one side you have the disbelief on the Italy election (although why markets are surprised we cannot fathom) and all that entails about rising uncertainty on the Euro. On the other is the fact buyers need to invest. From there it becomes a debate about whether the Italy election was just another minor stumble that can be glossed over, or is it part of a more significant fundamental shift? We suspect market fears, uncertainty, and the global fundamentals will likely see the Euro crisis reveal itself again in four distinct ways in coming months.

• Italy sold EUR 6.5bln in 5y and 10y BTPs this morning, solid b/c and competitive yields, especially when considering the  uncertain political situation in Italy.
• Moody's also said that Italian election is indirectly credit negative for other pressured EU sovereigns.
• Fears rise that ECB plan has a weakness as the strings in the Eurozone bond buying programme may be its frailty.

Italy is driving the markets. Japanese developments means the market is closer to give Abenomics its first test. Bernanke to set the record straight after many gave the regional non-voting Fed presidents too much weight in understanding trajectory of Fed policy.

See why Moody's downgrade of the UK credit rating is unlikely to impact the financial markets or UK policy.   One of the sub-arguments is that the divergence between the US and UK monetary policy in recent months cannot explain sterling's slide in the foreign exchange market.  Moreover, the UK's exports seem more inelastic to UK exports that the currency warriors would suggest.  

And another AAA-club member quietly exits not with a bang but a whimper:

MOODY’S DOWNGRADES UK’S GOVERNMENT BOND RATING TO Aa1 FROM AAA

Someone must have clued Moody's on the fact that the UK is about to have its very own Goldman banker, which means consolidated debt/GDP will soon need four digits. In other news, every lawyer in the UK is now celebrating because come Monday Moody's will be sued to smithereens. Cable not happy as it tests 31 month lows, which however also explains why the Moody's action has another name: accelerated cable devaluation. Those who heeded our call to short Cable when Goldman's Mark Carney was appointed are now 1000 pips richer. Also, please sacrifice a lamb at the altar of Goldman: It's the polite thing to do.

The financial world, at the moment, is a scary place. The signs of this are all about us and yet the consensus view is to worry about nothing. This has been caused by one singular action which is the orchestrated input of cash into the financial system by every major central bank on Earth. Money will go somewhere as it is created and so it has which is exactly why the markets are at or close to all-time highs while economic conditions have crumbled precipitously. It is not this market or that market which is in a bubble but all of them and it is systemic by its very creation. Politics, economics and the debauchery of the truth. There are consequences; there are always consequences. The world has subsisted on fantasies for four years but I think this spring will bring on the vengeance of the Fates for the demagoguery that has transpired.

Optimism it seems is all that matters (or is all that is allowed) as we are battered by dismal data left, right, and center. Of course, a reflection on the markets tells any 'smart' person that it all must get better - or why would stocks or sovereigns, or EURUSD be where it is? However, the 6 out of 10 15-24 year olds in Greece (61.7% to be exact) would beg to differ with that view of the world (as their economy grinds to a halt) - and with Spain reaching new highs at 55.6% (as well as the Euro-zone over 24%), all the bureaucratic lip-service in the world won't stop the revolt that is coming we fear.

As we noted yesterday, the credit bubble is in full swing as high-yield covenant protections hit a new low in January. At the same time, new issue premia in high yield credit has remained extremely low (meaning demand is high) - even as leverage (measured in a number of ways) surges to post-financial-crisis highs. With low yields and technical demand so abundant, firms appear to be leveraging-up in favor of shareholders. But, as is always the case, there is a limit to just how much leverage can be piled on before credit spreads 'snap' and raise the cost of capital - hindering the equity price. Finally, for the 'cash on the balance sheet' advocates, US firms' Cash/Debt is its lowest (worst) since pre-crisis. Banks continue to delever, sovereigns relever, and non-financials taking their lead - this didn't end well last time... and this time, exuberance and positioning is very heavy.

Confused what the earlier released statement by the G-7 means? Fear not, because here comes Goldman with a post-mortem. And just in case anyone puts too much credibility into a few sentences by the world's developed nations (whose viability depends in how quickly each can devalue relative to everyone else) in which they say nothing about what every central bank in the world is actually doing, here is a history of four years of G-7 statements full of "affirmations" and support for an open market exchange policy yet resulting in the current round of global FX war, confirming just how 'effective' the group has been.

Late on Friday Venezuela shocked the world when instead of reporting an update on the ailing health of its leader, as many expected it would, it announced the official devaluation of its currency, the Bolivar by nearly 50% against the dollar yet still well below the unofficial black market exchange rate. By doing so, it may have set off a chain reaction among the secondary sovereigns in the world, those who have so far stayed away from the "big boys" currency wars, or those waged by the Big 6 "developed world" central banks, in an attempt to also "devalue their way to prosperity" and boost their economies by encouraging exports even as the local population sees a major drop in its purchasing power and living standards. So in the game, where the last player to crush their currency inevitably loses, the question is who is next. The answer may well be America's latest best north African friend, and custodian of the Suez Canal: Egypt.

EuroStoxx (Europe's Dow) closed today -1% for 2013. France, Germany, and Spain are all lower on the year now. Italy, following ENI's CEO fraud, collapsed almost 3% from the US day-session open, leaving it up less than 1% for the year. Just as we argued, credit markets have been warning that all is not well and today's afternoon free-fall begins the catch-down. European sovereign bonds are no better with Belgian spreads the worst +13bps on the year. Italian bond yields are the highest in seven weeks (with spreads back above 300bps again today) as both Italy and Spain approach unchanged for the year. Europe's VIX closed at its highest in almost 3 months (aside from the 12/28 spike) as Swiss 2Y rates edge ever closer to negative once again. EURUSD broke back below 1.3400, its lowest in 10 days. Cue 'Cleanest Dirty Shirt' talk from US managers in 3...2...1...