Via Peter Tchir of TF Market Advisors,
I can’t help but feel that we are watching a performance this week. It feels like the actions, the meetings, and the statements are all very scripted. It seems reasonably clear which ending they are going for, but many of their actions also fit the “alternative” ending so it remains imperative to be cautious.
Roles for “bit” players have been cut
Last week, for the first time, the EU seemed to be able to muzzle the minor players and even limit the lines of the big players.
The Finance minister summit was a failure. Nothing useful came out of it. EFSF was a total flop. The bank backstop plans are at a national level and revolve around the idea of getting banks to borrow even more in the short term and not extend their maturities.
In spite of the obvious failure, there were relatively few comments. Rather than getting headlines of disputes, or even headlines of bigger and better ways to leverage, they seemed to let it die a relatively calm death and move on. This was a chance for every finance minister to get their quotations in the news, but they seemed reasonably constrained.
There were far fewer comments about the ECB or even from ECB members.
To me, it seems that the big players (Merkozy and Draghi) have taken control of the play and are trying to get it to the ending they want.
Germany took great pains last week to distance themselves from ECB decisions. The speeches made it clear that the ECB should be “independent”. This has been taken as a sign that Germany is relenting on letting the ECB print. By affirming the ECB’s independence, Germany can, in theory, explain that it wasn’t responsible for the printing. There is also a chance that this is a way to take the blame off of Germany if the ECB decides not to print. That seems less likely, but not everyone, especially at the ECB, believes printing is a solution, so this could be a way for them to take the focus off of Germany’s “nein”.
According to the script, Merkel and Sarkozy will become the Merkozy again tonight so that they can ride into this week’s summit with a “renewed joint focus”, blah, blah, blah. There is no way that they don’t act as though they have some agreement (even if they don’t). We won’t know what is discussed, we won’t know how much time is spent working out plans for a summit failure, all we will get is another handholding moment meant to encourage the market. I suspect that more time “off screen” will be spent discussing preparations for a failed summit, but all we will see is smiling confident faces.
At this point, I will give the politicians some credit. For the first time in months they seem to be writing the script. They aren’t just taking whatever script Wall Street hands them, and trying to act that out. The Wall Street scripts haven’t worked and have been unbelievable. The politicians are finally taking control and trying to develop their own plan, and selling Wall Street on how viable it is. Since they are politicians, they are actually trained at figuring out what can get done and selling it to the people. It probably won’t work, but at least they are doing what they are good at, and it would be hard to do worse than listening to another round of self-serving Wall Street advice. On a refreshing note, at least we have agreement on something, Wall Street and politicians now both think the other group doesn’t understand anything and has no sense of timing.
The “puppets” are pushing through austerity in Italy and Greece. They can be held up as shining examples to other countries of what needs to be done. They aren’t the heroes of the story, but are there so that the Merkozy can point them out and show that i) it can be done, and ii) when it is done, the EU and IMF will come through with additional funds. The “it” they got done won’t be well defined (but this is a movie, not the real world anyways) but the reward those good countries receive will be highlighted.
So the meeting will have Merkozy telling the smaller and problematic countries what a great future lies ahead for the eurozone. They will talk about the sacrifices they are making to ensure the viability of the future. There will be no criticism of the plan as only “friends and family” reports will get the inside scoop, and the “trailer” will be played over and over as part of the advertising campaign. We, the audience, will suspect that all the best parts of the play are in the “trailer” but we won’t be able to dig deep enough to argue against it.
The puppets will tell the other countries how happy they are that they have finally adopted austerity with growth to move forward and that they are excited about this opportunity to be part of the renewed commitment to the eurozone. Anyone who tries to figure out how austerity and growth work together, or where the money is coming, or any other details, will be escorted from room, and will be Clockwork Oranged into reading “fringe blogging websites” until they accept that details are bad, and only vague notions and slogans can “solve” anything.
At the end of the day, any holdouts will get invited to special meetings with the Merkozy. This is where they will be asked what they want to get in order to support the agreement, and reminded, that it is only an agreement in principle so they might as well say yes now, and they can always reject it later. These dark little meetings where the bribes are given and the futility of the agreement are discussed will only be available on the director’s cut, but will make people cringe when they realize what went on.
So in the end, according to script, everyone will get a chance for a joint communiqué and photo up where they talk about their commitment to implement these progressive changes. Every person who truly thinks about it for more than a minute, will know that it is a sham. They will see what has gone on, but it won’t matter. The “critics” will fall all over themselves to proclaim the success of the summit and that we are witnessing the birth of a new and better Euro. For a few days at least, the airwaves will be filled with the excitement that the “great leadership” exhibited by the Merkozy, and the diligence of the puppets, has led to such a monumental agreement. The future will be so bright, some might even “wear shades” when they discuss what has been accomplished. Tears wouldn’t even shock me.
Then before anyone can complain that the positive reviews were bought, or that the script is flimsy, we will see the next wave of activity. This will be like a giant publicity machine, trying to turn a horrible movie into an Oscar winner through the sheer strength of publicity and graft.
The ECB will cut rates by 50 bps. The ECB will announce further participation in the secondary markets and hint at the ability and willingness to print money. The IMF will announce some new programs. The EFSF will start participating in the primary market. Even the Fed might hint at future QE (if not actually doing anything).
Then the leaders can sit back and hope their magic works. Hope that their story has been bought and that the markets can take off and that they won’t actually have to implement much. Yes, I think this is the key here. They know that the treaty agreement changes are unlikely to be implemented. They know the ECB has limits, that the IMF is going to struggle to do what people seem to believe they can do, they just hope that this is enough to give the markets so much confidence that they don’t have to do anything. A market that can swing 6% on a 50 bp rate cut, might be manipulated into going so high that confidence is regained, long enough to buy time.
The “alternative ending”
So far, the directors have rejected the alternative ending. They don’t think that America in particular is ready for a non Hollywood ending, but they are filming some scenes just in case. Fortunately many of the scenes are exactly the same as in the preferred ending. In the alternative ending, Merkozy and the puppets can’t convince everyone to go along with the communiqué. They can’t convince them that it is really meaningless so there is no point to disagree. Somehow the summit ends without the decision to move forward.
If there is no agreement, then there will be no photo op, but the ECB will cut rates by 50 bps. The ECB will announce emergency actions to maintain stability in secondary markets while more discussions occur within the EU The IMF will announce some new programs. The EFSF will start providing capital to banks. The Fed will announce QE3 in an effort to fight deflation arising from the failure of the eurozone.
The alternative ending may actually be the right solution. Bank share prices would be hit hard. Countries will restructure their debt at the expense of banks and pension funds but could manage the new debtloads. Pension funds, after the losses, will have no choice but to cut benefits to reasonable levels. Somehow in this era where bank share price declines are equated with Armageddon, I don’t think we see the alternative ending yet. Extend and pretend is just so much more appealing.
We will go through the motions of the planned scripts. Many will shake their heads as the markets respond, but sooner or later (probably sooner), even those who fell for the media blitz will realize nothing is resolved. The problems are bigger than ever, and we will have to revert to a new plan. A plan that will have far less ability to contain the problem than it would now, because too many resources will have been wasted again.
Some strange “sub-plots”
There are a couple of sub-plots, that so far seem to be more like loose ends rather than being incorporated into the main plot. Neither fit in very well with the script as planned, but would take a prominent role in the alternative ending.
The Italian budget, which is helping today’s rally, includes provisions for Italy to guarantee new issues for its banks. So a plan that is meant to allow Italy to tap the market for its own, already large, needs is adding more potential debt? Sooner or later, the fallacy that guarantees don’t count has to end. If we were on risk-off mode, or afraid that the ECB wouldn’t just print, this news would be distressing. How can Italy really guarantee debt for its banks when its ability to issue debt remains in question? This is so unbelievable as to border on ludicrous, but it doesn’t fit into the main plot, so for the moment we are using the “suspension of belief” technique to move past this issue, but really, this is concerning, and shows how little true agreement there is amongst countries, and how willing they are to use words like guaranty as a “costless solution” to anything, in spite of the fact that a guaranty is neither costless nor a solution.
The other little side-plot is at the IIF. According to Bloomberg last week, Hung Tran, deputy managing director of the IIF said that a Greed deal “may be used as a prototype or a template for potential situations in other countries”. This was at a presentation he was giving at a hedge fund’s offices (which seems weird to me). Since no one on Wall Street with P&L responsibilities had ever heard of the IIF until a few months ago, we can only assume that most people view this as Tran’s attempt to extend his 15 minutes of fame into 17 minutes or a job offer. That is reasonable, because in spite of the big sounding titles this is largely a lobbying group that carries no weight with the banks. On the other hand, this little speech fits perfectly with the alternative ending theory. As mentioned above, each country would restructure to a certain degree, and the banks would bear the brunt of their own bad decisions. The comment that the Greek deal (which isn’t close to done, and I’m not sure the IIF is still involved in) could be used as a template, is very different than what Sarkozy said last week, but is truly scary if you think about it. Right now it is a dangling loose end in the plot and is probably meaningless as the character who said it, is so minor, but….
Watch the movie, but don’t buy the ending.
The play or movie will play out according to plan. We may get some brief dips in the market before the finish, but you probably need to accept the plot for now and go along for the right. Too many forces are pushing too hard for this not to play out according to the script. At some point it will be time to short the rally, but so long as the words of politicians and actions of central banks can drive the market higher, it is still too early to short, because we will get words from politicians and actions from central banks.
Any sense that the photo op scene at the end of the week is going to be cut, then get ready for a huge sell-off. If they cannot create the photo op at the end of this week, we will hit new lows. Vol is down, options are cheaper than they have been in awhile, so deep out of the money puts is best way to play the unlikely, but realistic alternative ending.