With the buying frenzy resuming on the lack of "headlines" out of Europe, it bears reminding that while risk on and off will be the theme of the day for a while, the entire Eurozone rescue, with the ECB refusing to participate directly, continues to be predicated on the EFSF and its ability to purchase the hundreds of billions of bonds rolling in the next 12 months from PIIGS, but mostly Italy, and now France. Which is why we are surprised that the news that the EFSF has now officially been "haircut" has not been quite noted. As Reuters reports, "political turmoil in Italy and Greece is complicating efforts to increase the firepower of the euro zone's bailout vehicle to 1 trillion euros, an official at the European Financial Stability Facility said on Friday. Euro zone countries had hoped to increase the EFSF's lending capacity by December, combining bond insurance with investment vehicles. But after the government in Athens fell and bond markets pushed Rome to the brink of a bailout that the euro zone cannot afford to give, the Luxembourg-based EFSF thinks it may be more realistic to aim for less leverage." In other words: kiss the full capacity bailout goodbye. And as the chart below shows, kiss any hope that the EFSF will be able to participate meaningfully in any European "renaissance" - while BTPs and OATs have seen some modest tightening on this "risk on" day, the yield on the EFSF has done absolutely nothing and remaind glued to record wides.
Reuters with some more on the encroaching math fail:
"The political turmoil that we saw in the last 10 days probably reduces the potential for leverage, so that may be only by three to four times, instead of four to five," the EFSF source said.
Investors have shunned bonds issued by highly indebted euro zone countries and luring them back by offering insurance on losses, the centrepiece of a plan agreed in Brussels late last month, would probably use up more of the fund's resources.
After deducting the EFSF's existing emergency funding programmes, the rescue fund has 250 billion euros ($340 billion) to leverage.
The EFSF says it expects financial markets to improve as Greece appoints a new crisis cabinet and Italy votes on austerity measures demanded by the European Union, taking more dramatic action to reassure investors it can reform its economy.
But investors were already questioning how the EFSF would reach the 1 trillion euro level -- aimed at helping Italy and Spain if they were shut out of capital markets -- after the Oct. 27 agreement.
The idea of raising the firepower via possible special purpose vehicles financed by sovereign wealth funds and other global investors is in some doubt because of a lack of clarity on incentives for countries such as China or Brazil to invest.
Which means the ball remains in the ECB's court. And like in the US, in order to force the ECB's hand, risk has to sell off, yet the market is now pricing in intervention by both the Fed and the ECB and is sending risk ever higher in a toxic catch 22.
As usual the market will need a few days to process the math.