The (European) Show Must Go On

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From Peter Tchir of TF Market Advisors

The (European) Show Must Go On

It looked like S&P had gone off script.  They slapped a negative watch on any euro country that didn’t have it already.  They even came out with details about which countries faced 1 notch and which faced 2 notches.  I’m glad I didn’t have this information on Friday as I wouldn’t have bet we would be up 1.5% on the week given that move.  Now, it looks like this move has been incorporated into the plot.  It puts added pressure on the countries to come to a “resolution” this weekend.  It is being viewed as increasing the likelihood of a deal since the countries all want to avoid the downgrade.  If they do reach a deal, then taking them off watch could add to the post photo-op rally.

A few weird things about the S&P action.  They didn’t put EFSF on watch, though that has to be an oversight since from their own memo they should have put it on.  I feel almost bad for little Estonia.  According to Bloomberg they have no debt.  They were just upgraded from A to AA- on August 9th, and now look like they could lose that rating.  Yes, S&P upgraded Estonia less than 4 months ago.  The fact that the rating agencies have so much impact on regulatory capital and have some designation as nationally recognized something or other is just a joke.  That they hide behind “freedom of speech” arguments when they get it wrong is even more bizarre.  The CPDO trial in Australia is interesting if not precedent setting.

Nowotny came out with some comments that downplayed ECB help.  That didn’t help the market, but may well have been another step towards pushing countries to claiming they have a deal by the end of the week.  It is important to note that it was Nowotny and not Draghi, as it makes it easy for them to change direction if they get the EU announcements that have been scripted.

Last Tuesday, the Italian 5 year bond closed the day at 7.61% yield.  It is now at 5.95% which is 166 bps tighter.  Pretty impressive.  German 5 year yields are 16 better, so that is an improvement of 150 bps on a spread basis.  German CDS is 15 tighter over the same timeframe, but Italian CDS at 435 is only 90 tighter from last Tuesday’s 525 close.  The outperformance of bonds is worth looking at.  The cynical side screams intervention and ECB purchases were the key (since they don’t yet sell CDS).  I can’t tell if the potential for the ECB to print money has any impact since the CDS trades in $’s and there is always some FX element to the trading.  Short Spanish bonds and sell Italian CDS is a possible trade.

Geithner has been invited to the set (possibly self-invited).  I am not sure what he can do, and doubt he can really add anything as I still believe he has cause and effect all mixed up on what happened here. The media, though has latched on to the visit as another positive, as his advice is “invaluable” (it hurt to type that) and that it may indicate our support of the IMF (in spite of what our elected representatives may want).

Probably time to fade the rally a little bit.  MAIN has been in about a 2 bp range all day.  No one knows what to do, but after the massive rally, some doubt is creeping in.  In spite of near term potential to fade the rally, the script still seems intact. My expectation of some photo-op with enough of a [bogus] agreement to let the alphabet soup of entities to send out positive headlines, cut rates, and hint at more money to come is still the likely outcome for the end of this week and early next week.