Submitted by Peter Tchir of TF Market Advisors,
Do we finally get details out of Europe?
Spain has finally made the “formal” request for aid [ZH: and Italy is right behind them this morning]. There is another summit. Expectations for anything positive seem incredibly low. There seems to be a scramble to shoot down anything that is said out of Europe. It really doesn’t matter what is said, the negatives and potential negatives, and imagined negatives get the traction.
Details will be required for the market to
- Believe anything real is going to occur and Europe isn’t just trying to prop up the markets with talk
- Analyze the impacts of any programs to figure out what they will actually do and what they can accomplish
Today, so far we are back to disappointment and fear mode. Some of the fear seems to be overdone, again, such as what Juncker said about “restructuring” for the financial system. His quote seems to be directed at the financial system in Spain, which does need to be restructured, but has been taken to apply to the country. Without details it is speculation either way, but is another example where right now the market is in the mood to price in the worst interpretations of every statement. Details are needed.
Details are needed now. Spanish bank recap details. Greek renegotiations and other plans for the EU have to be put on the table, with the details included. The market cannot survive at these levels with weak economic data and no belief the EU is actually going to do anything useful.
At the same time, many of the ideas for what Europe should do are horribly wrong, yet have managed to gain traction.
Don’t Buy Bonds in the Secondary Market
Of all the things people want Europe to do, buying bonds on the secondary market seems the least effective [ZH: which Novotny has now explained the ECB will not undertake]. Any program that has a chance of working has to help both the sovereigns and the banks. If an action only helps the sovereign or the bank it is less likely to succeed. If it helps neither, than it is a total waste of limited capital.
Secondary Bond Market Buying Does Not Help the Sovereign
- Changes in secondary market yields do not immediately affect the average coupon paid by the issuer, and can take years to have a meaningful change on the borrowing costs
- Rallies sparked by secondary market activity have been short lived and markets normalized quickly with little to show for it other than an underwater portfolio at the ECB
- The subordination and unwillingness to participate in any potential restructuring was a problem in Greece and remains one of the main reasons why Greece is only partially through their default
Secondary Bond Market Buying Does Not Help Banks
- Banks, particularly those in Spain and Italy hold their sovereign debt in “banking” or “accrual” books where they are not impacted by market prices so long as they don’t sell. They are NOT selling. The banks are already “all-in” the sovereign trade and are not taking losses to reduce positions
- The losses have no impact on their “earnings” and with the ECB being lenient on collateral requirements, the secondary market prices have even less impact than normal for banks using the ECB or LTRO to fund the positions
So don’t waste the money on secondary market purchases. The money barely helps the sovereign and does nothing for the banks. It may help some speculators who will buy ahead of the activity, but will be quick to get short again when the time comes.
Cheap, Long Dated, Primary Intervention is Best Hope
Providing low cost, long maturity debt to sovereigns is the best outcome. It would allow debt maturities to be handled taking near term default risk off the table. By pushing out maturities, the near term default risk is further reduced. Low coupons do have an impact on the current budget.
Access to cheap long term money will actually help secondary market spreads as well. The degree of subordination will affect how much secondary market spreads benefit, but as secondary market spreads or yields are relatively unimportant.
Getting the cost of funds down and extending average maturity is effective and is something that may be relatively easy to accomplish within all the existing programs that the EU has at their disposal.
Bank Recapitalizations – finally?
Bank recapitalizations would be even better than just cheap money for the sovereigns, but seem far more difficult to achieve. The fact the Greek banks aren’t yet recapitalized is a failure. The fact that the ECB and EU took pressure of banks throughout Europe earlier this year when the markets were calm was another grievous mistake. The Spanish bank recap plan is a chance for them to redeem themselves.
We will have a better idea of how successful the plan will be once details come out, though given low expectations, it still seems very likely to surprise to the upside.
Does Anything Else Matter?
Not really. Maybe the economic data will be so different than expectations that it will have a large impact, but that seems unlikely. The data has been weak, and consistently weaker than expected, so each miss has less of an impact. A few positive surprises might help, but those are only likely to help or hurt the market at the margin. The real key is any clear direction from Europe. I expect that Europe is actually going to surprise to the upside, but every day we go without details and with negative comments, we will see markets remain under pressure.