Portugal

There was little in terms of overnight newsflow to spook algos, but the tone is decidedly sour this morning following a lack of either the now traditional Japan or Europen-open buying ramps. The primary reason for this may well be the ongoing decline in the USDJPY which failed to breach the 100 barrier yesterday, coming as close as 99.95 before the Mrs. Watanabe onslaught had to be called off despite some more jawboning from Kuroda whose headlines are now summarily ignored, and which appears to have set a line in the sand for Japan, whose market naturally closed lower following this strengthening in its currency. Similarly troubling was the dip in the SHCOMP which closed down -0.58%, this despite the epic M2 and credit injection reported yesterday: if new liquidity can't send the market higher, what can?

Among the surprises of the week: the dollar has not gone above JPY100, JGB yields have risen this week, Portuguese bond yields have fallen.

The troubles in Cyprus have set off a new examination of the health of the eurozone, with a particular focus on which country might be next in line for a bailout and the extent to which shareholders and depositors will take losses when banks fail (bail-ins). As UK think-tank, OpenEurope notes, much of the attention has settled on two countries. Portugal, which has been propelled back into the headlines, with the country’s constitutional court recently ruling against some of the government’s EU-mandated budget cuts. Secondly, Slovenia, which is facing a massive banking crisis, in turn providing another potential testing ground for the eurozone’s vaguely defined ‘bail-in’ plans. OpenEurope provides a quick run-down of the key points to watch in each country.

Disparities, bailouts, and a slow-motion blowup.

Futures green? Check. Overnight ramp in either the EURUSD or USDJPY carry funding pair? Check? Lack of good economic news and plethora of economic misses? Check. In short, all the ingredients for continued New Normal record highs, driven only by the central bank liquidity tsunami are here. The weakness started with Australia's stunning unemployment jump overnight which saw a 36,100 drop in jobs on just 7,500 expected. A miss in Chinese auto sales was next, with 1.59MM cars sole in March, below the 1.596 expected, and even despite the surge in M2 and loan data, the Shanghai Composite closed down once again, dropping 0.29% to 2219.6. Nikkei continued its deranged liquidity-fueled ways, rising 1.96% even as Kuroda is starting to become quite concerned about the rapid move in the Yen, saying he "may adjust policy before the 2% target is reached if the economy and other indicators are growing rapidly." They aren't, and won't be, but if the Nikkei225 is confused for the economy, he just may push on the breaks which would send the only reason for the latest rally, the USDJPY tumbling. Finally, looking at Europe, Italy sold well less than the maximum €6 billion targeted in 2016, 2017 and 2028 bonds, which dented some of the enthusiasm for Italian paper although with Japanese money desperate to be parked somewhere, it will continue going into European and all other fixed income, distorting market signals for a long time. In short, expect the central-bank risk levitation to continue as all the deteriorating fundamentals and reality are ignored once more, and hopium and P/E multiple expansion are the only story in town.

Wondering which dominoes are next to fall in Europe? Here is a list based on a simple but powerful precept: follow the smart money. In this case, the smart money entered the at-risk banking sector of a particular nation to skim the fat premium offered by its higher interest rates--rates that reflected the higher risk. The smart money then exits the nations' banking sector before the inevitable solvency crisis triggers capital controls and depositor expropriations (the comically misleading "bail-in"). Why is any money left in at-risk periphery banks? "Things fail from the periphery to the core." With this in mind, we might arrange the dominoes in this order: Slovenia, Portugal, Malta, and then Spain.

When European governments buys goods and services they often do not pay their suppliers in full. Many countries in the euro area are in arrears. These are not included in the Maastricht definition of debt. Italy is the most egregious and this in turn has aggravated the credit crunch for the SMEs and increase the non-performing loans at banks.

• JPMorgan Leads Job Cuts as Banks Seek to Bolster Profit (BBG)
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• Portugal may face delay to bailout funds (FT)
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• Spain’s PM wants more powers for ECB (FT)
• Bernanke Says Interest on Reserves Would Be Main Tightening Tool (BBG)
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• Texting While Flying Linked to Commercial Helicopter Crash (BBG)... No, Bernanke wasn't the pilot

Austerity is under attack again, with Cyprus about to enter a program. Critics charge that austerity is self-defeating because it depresses growth, pushing up the debt/GDP ratio. However, austerity is a necessary (although far from sufficient) condition for countries with low national savings Indeed, there is some evidence that austerity is beginning to have positive effects. The only way to raise net savings is to cut consumption, which is much more difficult than cutting investment. Higher savings have improved market perceptions of debt sustainability, making countries more resilient to shocks (Cyprus, Italian politics). To be sure, European governments have been guilty of false advertising. They claimed that fiscal austerity would not hurt growth. But in order to raise savings, it is necessary to consume or invest less (unless a country is lucky enough to enjoy an export or productivity boom). As a result, growth will suffer as a country raises savings. But once savings begin to recover, elements of a "virtuous circle" begin to fall into place.

European bank stocks are officially in bear market territory, now down over 22% from their highs with today's drop closing the index at seven month lows. Financial stocks have played catch down to credit's early warning weakness but still have more room to run. The correlation between financials and sovereigns has been notably broken down in the last few weeks - as it seems an external funding source has saved European sovereign debt (perhaps one that just wants to get away from its vicious cycle-like devaluation and diversify into anything non-JPY-denominated). On the day, Portugal blew wider at the open (+22bps) only to be magnificently bid back to unchanged by the invisible hand. Spain and Italy drifted slightly tighter on the day. Stocks were similarly low range today. Swiss 2Y closed at 3-month lows as EURUSD retraced back from its highs to close practically unchanged from Friday at 1.3000.

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• Central banks move into riskier assets (FT)
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• North Korea Pulls Workers From Factories It Runs With South (NYT)
• Illinois pension fix faces political, legal hurdles (Reuters)
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• Portugal Seeks New Cuts to Stay on Course (WSJ)

With every modestly positive datapoint being desperately clung to, now that even Goldman's Hatzius has once more thrown in the economic towel after proclaiming an economic renaissance in late 2012 just like he did in late 2010 only to issue a mea culpa a few months later (and just as we predicted - post coming up shortly), the key prerogative is to ignore the elephant in the room. That, of course, is that the JPY 1 quadrillion bond market had to be halted for the second day in a row as the Japanese capital markets are fast becoming a very big and sad joke. The resulting flight to safety from Japanese investors, who sense that their own bond market is on the verge of breaking down completely, has managed to send French and Belgian bonds to record lows, the Spanish 2 Year to sub 2%, the German 6 month bill negative in the primary market, the US 10/30 year constantly bid and so on. The immediate result is that the bond-equity disconnect continues to diverge until one day we may get negative 10 Year rates coupled with an all time high stock market. Gotta love the fake New Normal market, in which the Japanese penny stock market was up another 2.8% to well over 13,000 even as the Shanghai Composite plumbs ever redder territory for 2013 on fears the birdflu contagion will hurt the already struggling economy even more.

A big picture look at the drivers of the global capital markets.

It seems, despite the constant "it's all fixed" banter, that Portugal's Constitutional Court decision that the Troika-imposed austerity is unconstitutional (as we discussed in detail here and here) has a few of the 'elites' nervous. And so, late on a Sunday night European time, they launch a press release that is about as passively aggressive as they come, "any departure from the programme's objectives, or their re-negotiation, would in fact neutralize the efforts already made and achieved by the Portuguese citizens, namely the growing investor confidence in Portugal, and prolong the difficulties from the adjustment... it is a precondition for a decision on the lengthening of the maturities of the financial assistance to Portugal." In other words, get your constitutional court in line or the OMT 'promise' get's it! Perhaps that explains why, unlike Spain and Italy who rallied in the last few days, Portugal's bond spreads are at the widest of 2013 (70bps off the tights of the year).

Portugal's court ruling and Italy's caretaker government decisions briefly discussed.