The Euro 2012 football competition has entered its elimination stages. According to Citi's Matt King - one of the few respectable strategists out there - the elimination round has also arrived for the other EURo. There is still hope, but it is rapidly fading, and every additional half-baked, semi-efficient "resolution" only confirms the skepticism of the ever-increasing crowd of naysayers: summits, summits, and more summits, all the while nothing changes, and the German population: the only source of any European stability, is becoming increasingly belligerent toward the entire European experiment. The other problem: we are now in the first session of extra time. So even as Germany inches ever closer to winning it all in the European football arena, will the tradeoff be a loss for everyone else who now relies exclusively on German benevolence? A few days ago, David Marsh, writing "Don’t count on Germany’s economic surrender [8]" in the FT, made just this point. And he is right. Yet the capital markets, after nearly throwing in the towel on Spain last week, have rebounded strongly giving some hope that this time something may be different. It won't be. King explains.
Despite this week’s squeeze tighter in CDS, and still relatively limited widening in cash bonds, it is hard to escape the feeling that the rallies are becoming shorter as the stakes become bigger. The market’s failure to rally for more than a few hours on about the “best” Greek election result it could have hoped for seems highly significant. Investors seem to be “seeing through” the partial solutions, and anticipating the endgame, more rapidly than was the case previously.
When your only investment strategy is prayer, it is probably not a good thing:
That the sell-off has not been bigger owes much to the anticipation of a policy response. CDS and especially cash are much tighter than they were last November, even as Spain has been reaching new wides. Investors have been reluctant to sell cash bonds given the growing likelihood that the ECB calls for extra time, most likely through a rate cut, relaxation of collateral rules and perhaps a new, potentially 5-year, LTRO.
But we have serious doubts as to the effectiveness of such measures in providing a long-term solution against a backdrop of rapidly weakening economic growth and growing fears about ultimate sovereign solvency in both Spain and Italy. The effectiveness of the first LTROs was due not only to the liquidity they provided, but to optimism that they represented a more determined approach to solving the crisis.
A broke Europe may be full of sound and fury, demanding everything from Merkel, yet all she can say is "nein", signifying everything.
This time, despite a rowdy chorus of policy suggestions from the IMF, the US and others on the sidelines, we see little sign that Germany is prepared to concede just yet, nor that the ECB is prepared to change the rules of the game entirely. The main focus of optimism following the G20 was the prospect of €600bn in EFSF/ESM bond buying, yet such a possibility was promptly described by Germany as being “theoretical”. On the even more critical questions of direct injections to banks, and the ECB granting the ESM a banking licence, the answers still seem to be “nein”. Likewise, on their own turf the Fed’s failure to do QE suggests an awareness that even referees are conscious of the limits to their authority.
So moving on to the football analogies, and an ending that will hardly leave many happy.
We can imagine steps which would justify a more positive stance, but they need to be game-changing substitutions, not the sort of half-measures we have seen to date. That means innovations like having the EFSF/ESM cap the yields on primary auctions in Spain and Italy (and thereby hoping to avoid downgrades to junk from the other agencies, if not from Moody’s, who seem to take the strictest line on any form of official sector support). The creation of a proper deposit guarantee scheme (covering redenomination risk), with the possibility of temporary funding from the ECB, might also help stem the steady deposit flight and allow banks to step up their purchases of government bonds.
So, like fans everywhere, we remain glued to our screens. If coming weeks lead to a new, combined and coordinated €600bn plan to bail out both Spain and Italy by supporting their primary markets, with additional ECB liquidity providing stimulus to bank buying and hence helping avoid associated downgrades to junk, markets will rally strongly. In contrast, anything short of this, or a more “conventional” bailout programme for Spain which fails to address Italy, could easily lead to the crowd’s mood turning much uglier.
And just like Germany winning it all, so the mood turing much uglier, if only so Germany can pass its European federalist agenda with no opposition, is precisely what Germany wants. And what Germany wants, Germany gets.
In conclusion...
After all, this is not some endless league in which points deficits can go on being accumulated indefinitely thanks to the grace of TARGET2. This is Euro 2012, and arguably we have had at least one session of extra time already.
At this point not even we know when he is referring to a meaningless sports tournament, and when to a soon to be meaningless and failed monetary experiment.