Portugal

The last hour has spewed forth more disingenuous clap-trap from European finance ministers. From 'sufficiency of the firewall' to the 'absurdity of Spain needing a bailout', it beggars belief that these humans can look at themselves in the mirror every morning (as they feel the 'need' to lie' - or are simply ignorant of the reality). At some point in the near future there will be about €40 billion of money sitting in the ESM and a bunch of promises from countries failing to live up to existing debt obligations, and that is the big firewall? The correlation between who is providing the guarantees and who will need them cannot be ignored. This new €500 billion number doesn’t exist, it’s not just meaningless, it’s non-existent if Italy or Spain needs money. People can take away whatever they want, but unlike LTRO which had real injections of liquidity, this is just like the July plans from last year and the November “grand” plans. It sounds great, especially when too many people are willing to blindly follow what the politicians want them to, but it doesn’t work in practice.

Back in early February, the ECB's Margio Draghi told a naive world when discussing the implication of taking LTRO bailout aid, that “There is no stigma whatsoever on these facilities." We accused him of lying. Additionally, we also suggested to put one's money where Draghi's lies are, and to go long non-LTRO banks, while shorting LTRO recipients. In two short months the spread on that trade has doubled (see below), which intuitively is not surprising: after all, as a former Goldmanite (and according to some - current), Draghi is merely treating Europe's taxpayers like the muppets they are. As such, fading anything he says should come as naturally as Stolpering each and every FX trade. Yet what that little incident shows is that despite all their attempts otherwise, the central planners can not contain every single natural consequences of their artificial and destructive actions. Today, we see learn that the same Stigma we warned about, and that Draghi said does not exist, is starting to spread away from just the bailed out banks (becuase we now know that the LTRO was merely a QE-like bailout of several insolvent Italian and Spanish banks), and to sovereigns. From Bloomberg: "Germany’s Bundesbank is the first of the 17 euro-area central banks to refuse to accept as collateral bank bonds guaranteed by member states receiving aid from the European Union and the International Monetary Fund, Frankfurter Allgemeine Zeitung reported." And where Buba goes, everyone else is soon to follow. And what happens then? Since it is inevitable that Spain and Italy will be next on the bailout wagon, what happens when over $2 trillion in bonds suddenly become ineligible for cash collateral from the only solvent central bank in the world (aside for that modest, little TARGET2 issue of course). Will it force the ECB to be ever more lenient with collateral, and how long until the plebs finally realize that the ECB has been doing nothing but outright printing in the past 5 months? What happens to inflationary expectations then?

When considering the financial condition of each and every country in the European Union there are certain facts that are left out and left out on purpose. In our opinion, the structural deformity of the European Union is, in itself, one of the main reasons that any attempt at a fiscal or economic fix never seems to work. Whether some proposed firewall is $760 billion or $1.3 Trillion or $13 Trillion makes no difference as in zero, nada, nothing and null. It is an IOU, a promise to pay and it is not counted in any European sovereign debt numbers nor is it counted in the figures for the European Union’s debt. It will not stop Spain or Portugal or Italy from asking for or needing money. This whole discussion is a head fake, a deception and a ruse carefully plotted out for investors in one more attempt to mislead the entire world. If you wish to be a statistic in the Greater Fool Theory be my guest but I refuse to be apart of this unadulterated scam.

The last month has seen a considerable amount of the post-LTRO gains in Italian and Spanish Sovereign and Financial credit markets (and stocks for the latter) given back. The stigma priced into LTRO-encumbered banks has also surged to post LTRO record wides - more than double its best levels now. This is hardly surprising - while the LTRO was nothing but a thinly-veiled QE printfest, it is the action that was taken with that newly printed money that has created dramatially more contagion risk and sovereign-financial dependence as an unintended consequence. The collosal (relative and absolute) size of the reach-around Sarkozy carry-trade buying in local sovereign debt for Italy and even more so Spain is highlighted dramatically in these 3 charts for BNP, most notably the increase in banks' holdings of sovereign debt compared to their share of Eurozone sovereign debt - i.e. the banks in Italy, and more so Spain, are hugely more exposed to their sovereign's performance and with Spain's massive budget cuts - a vicious cycle of austerity to growth-compression to credit-contraction to Greece (firewall or not) is leaking into their bond markets, even with an active ECB doing SMP although inflation-constrained from LTRO3 perhaps.

As noted earlier, futures this morning are higher despite a plethora of economic misses (and despite 57% of March US data missing as per DB), simply on regurgitated headlines of an "expanded" European €7/800 billion bailout fund. There is one problem with this: the headlines are all wrong, as none apparently have taken the time to do the math. Which, courtesy of think tank OpenEurope, is as follows: "The real amount of cash that is still available to back stop struggling states, should it come to that, is only around €500bn." Of course, that would hardly be headline inspiring: recall that that is simply the full size of the ESM as is. But even that number will hardly ever be attained, and the ECB will have to step in long before Europe needs anything close to a full drawdown: "The problem here is that if it’s too big and terrible to ever be used, it’s likely that it won’t ever be used. Even jittery markets will be able to figure out that a large fund which would damage French and German credit ratings if ever extended will never be fully tapped. So clearly some circular logic at play. And let's not forget that it’s still far too small to save Italy and Spain should if worse come to worse." Circular logic? Check. Another check kiting scheme? Check. Spain and Italy still out in the cold? Check. Conclusion -> buy EURUSD, and thus the ES, which has now recoupled with every uptick in the pair, but not downtick.

All you need to read and more.

I looks like a few home runs are in the making...

Much of the fiscal and monetary insanity that has come out of the EU over the last two years can be summated by one of my central global theses: politics determine Europe's policies, not economics. And Europe now appears to be shifting towards a more leftist/ anti-austerity measure political environment. If this shift is cemented in the coming Greek, French, and Irish elections/ referendums, then things could get ugly in the Eurozone VERY quickly.

All you need to read and more.

The sad reality of an austerity induced slowdown in Europe and an ESFS/ESM as useful as a chocolate fire-guard seems to be creeping into risk asset premia across Europe (and implicitly the US). GGB2s are all trading back under EUR20 (that is 20% of par), Sovereign yields and spreads are leaking wider despite the best efforts of their respective banks to back-up-the-truck in the 'ultimate all-in trade' and the LTRO Stigma has reached record levels as LTRO-encumbered banks' credit spreads are the worst in over two months. Spanish sovereign spreads are back at early January levels and with Italian yields comfortably back over 5% and the bonds starting to reality-check back towards the much less sanguine CDS market. It seems apparent that much of the liquidity-fixing LTRO benefits are now being washed away as investors realize nothing has changed and in fact things are considerably worse now given encumbrance and subordination concerns and the increased contagion risk that the LTRO and the Sarkozy trade has created.

Austerity hasn’t worked for countries.  So far the austerity path has made situations worse, rather than better.  Without stimulus, economies have seen their problems compound.  So now virtually everyone is against the idea that austerity is helpful. That takes us back to spending.   Maybe it’s just me, but spending is what got us into this mess in the first place.  If spending worked so well and was so easy we wouldn’t have a sovereign debt crisis in the first place.  Virtually every country was spending, yet deficits grew and economies shrank.  Why is there any faith that spending now will work?  Are we so good at targeting specific things that will really, truly, work?  Not a chance.  Spending will ensure debt grows just as fast, make the problem even bigger in the end, but will make people slightly happier in the near term. So if austerity doesn’t work, and spending hasn’t worked, what will? PSI, or Default, or Restructuring.

• Obama budget defeated 414-0 (Washington Times) yes, the Democrats too...
• German Central Banker: ECB Loans Only Buy Time (AP)
• Baku grants Israel use of its air bases (Jerusalem Times)
• Japan May Understate Deflation, Hampering BOJ, Economist Says (Bloomberg)
• BRICS flay West over IMF reform, monetary policy (Reuters)
• Five Portugal Lenders Downgraded by Moody’s (Bloomberg)
• SEC Registration Captures More Hedge Fund Advisers (Bloomberg)
• EU Nears One-Year Boost in Rescue Fund to $1.3 Trillion (Bloomberg)
• Consumers plot emergency oil release as Saudi decries high prices (Reuters)
• Japan Plans to Draft Stopgap Budget for First Time in 14 Years (Bloomberg)

Nothing has changed. You are counting the commitments of people who need the money.  It is like getting a loan from the bank and trying to make them more comfortable by telling them, not only will we co-sign our own loan, but we will give them a guarantee that we will pay it back. These are the same people who constantly try to overwhelm current problems with huge headlines and promises of a better future.  They don’t have the money, and never will.  They also promised speculators in Greece would lose their shirts. We need to see the details, but be prepared to be underwhelmed.

With Chinese and European data disappointing and Weidmann commenting on the futility of the 'firewalls' (as we discussed earlier) ahead of the discussions later this week, European equities dropped their most in almost three weeks over the last two days closing right at their 50DMA (the closest to a cross since 12/20). Credit markets (dominated by financial weakness) continue to slide as the LTRO euphoria wears off. The LTRO Stigma, the spread between LTRO-encumbered and non-LTRO-encumbered banks, has exploded to over 107bps (from under 50bps at its best in mid Feb when we first highlighted it) and is now up over 75% since the CDS roll as only non-LTRO banks have seen any improvement in the last week. Aside from Portugal, whose bonds seem to be improving dramatically on the back of significant Cash-CDS basis compression as opposed to real-money flows as the spread between Bonds and CDS has compressed from 500bps to 250bps on the back of renewed confidence in CDS triggering, sovereign bond spreads are leaking wider all week with Italy and Spain worst.

Germany's recent 'agreement' to expand Europe's fire department (as Goldman euphemestically describes the EFSF/ESM firewall) seems to confirm the prevailing policy view that bigger 'firewalls' would encourage investors to buy European sovereign debt - since the funding backstop will prevent credit shocks spreading contagiously. However, as Francesco Garzarelli notes today, given the Euro-area's closed nature (more than 85% of EU sovereign debt is held by its residents) and the increased 'interconnectedness' of sovereigns and financials (most debt is now held by the MFIs), the risk of 'financial fires' spreading remains high. Due to size limitations (EFSF/ESM totals would not be suggicient to cover the larger markets of Italy and Spain let alone any others), Seniority constraints (as with Greece, the EFSF/ESM will hugely subordinate existing bondholders should action be required, exacerbating rather than mitigating the crisis), and Governance limitations (the existing infrastructure cannot act pre-emptively and so timing - and admission of crisis - could become a limiting factor), it is unlikely that a more sustained realignment of rate differentials (with their macro underpinnings) can occur (especially at the longer-end of the curve). The re-appearance of the Redemption Fund idea (akin to Euro-bonds but without the paperwork) is likely the next step in countering reality.