Portugal

The Greek new-election news this morning pushed sovereign spreads wider across the board in Europe. Spain and Italy have leaked back off those high spread levels in the last hour (while Portugal has not) but critically, Spain is rapidly approaching a very significant Maginot Line, as noted by Bloomberg's chart-of-the-day today. In the past (in the case of Portugal and Ireland) when the bond spread on European sovereigns relative to AAA-rated European debt has reached 450bps, the LCH has slapped on significant margin hikes. At a time when cash/collateral is in extremely short-supply (as indicated most obviously by the rapid deterioration in EUR-USD basis swaps recently), Spanish 10Y spreads are perhaps a day or two of weakness away from the point of no-return. When Portugal broke this level it rapidly accelerated from 450bps to over 800bps in less than three months.

Earlier, we reported on media speculation that this was a done deal. We now get confirmation.

• GREEK FINANCE MINISTRY TO PAY EU435 MLN BOND
• GREECE SAYS TODAY'S DECISION DOESN'T PREJUDICE FUTURE DECISIONS - no, just those you have to COMPLY with

In other words, just as Zero Hedge predicted in January, non-Greek law bondholders, who did not comply with the PSI, had all the leverage. And again: congratulation to all those who were not Steve Rattnered into agreeing to the PSI, and held out: the 135% annualized return is worth it. Just keep this in mind when the PSIs of Portugal, Ireland, Spain and Italy take places next.

With the Greeks unable to hug it out and new elections (as per Venizelos and Kammenos) all but guaranteed, the probability that Greece will exit just went to 11 on the dial. Markets hiccupped and plunged, giving up all the German GDP gains and then some. EURUSD traded back below 1.2800 - trading 1.2780 as we post, S&P 500 e-mini futures dumped 13 points now below yesterday's lows, Europe's DAX took a dive, and all European sovereign bond spreads tore higher dominated by Portugal, Spain, and Italy (+38-48bps on the week now). Credit spreads are gapping wider in Europe and the US. Commodities, which had been limping a little higher - on weaker USD and growth-hopiness we suppose - have reversed those gains with Silver and Oil underperforming. Treasuries and Bunds in lockstep and notably lower in yield - to lows of day.

Germany's Bundesbank confirmed yesterday that the German gold reserves are held overseas by the Federal Reserve, the Bank of England and the Banque de France. The German parliament, the Bundestag, has been examining the accounting of German gold reserves at the Bundesbank. The parliament's Budget Committee, one of the most powerful committees in the German parliament, had requested a critical report by the Federal Audit Office. "The decision has been unanimous," the paper quoted the Christian Social Union budget expert Herbert Frankenhauser. The newspaper report alleged "account cheating" regarding the German gold reserves. According to a Bild report, the federal auditing office complained of "inadequate diligence of the accounting of the gold reserves, which are stored in some foreign countries. Repatriation of the gold reserves is encouraged.” The Bundesbank confirmed that it, like many central banks, keeps part of its reserves in vaults at foreign central banks and said some of its gold is held at the Federal Reserve Bank of New York, the Banque de France and the Bank of England. It declined to say how much gold in total is held overseas or how much gold is stored with the Federal Reserve, Bank of England and Banque de France. The Bundesbank statement said it had complete confidence in the integrity of the central banks where the gold is held. "From these central banks, the German Bundesbank annually gets confirmation of the gold holdings in troy ounces as a basis for its accounting," the Bundesbank’s statement said.

• JPMorgan Said to Weigh Bonus Clawbacks After Loss (Bloomberg)
• Obama Says JPMorgan Loss Shows Need for Tighter Rules (Bloomberg)
• Greeks Try New Tack, Seeking Technocrat Slate (WSJ)
• Euro zone finance ministers dismiss Greek exit "propaganda" (Reuters)
• Romney’s business record under fire (FT)
• Tide Turning in Japan Deflation Fight, BOJ’s Top Economist Says (BBG)
• Euro Chiefs May Offer Leniency to Greece (Bloomberg)
• Portugal's Progress Won't Guarantee Funding (WSJ)
• EU Bank-Liquidity Bill Proceeds; U.K. May Protest (WSJ)
• Cameron pressed to boost enterprise (FT)

As already noted, one piece of good news out of Europe - German GDP (ignore the huge ZEW miss) - was enough to make everyone forget the Italian bank downgrade, and that Greece is one election away from unwinding the EMU. Yet perhaps it is good to have a modest bounce from a market, which however not even Goldman says is oversold: after all the central planners need a day or two to regroup, and consider what currency to crush next to buy the global nominal stock market a few months of breathing room.

There was little good news out of Europe overnight, when several key countries (Germany, France, Greece and Portugal) reported their Q1 GDP, but what good news did come, namely that Germany avoided a double dip, with Q1 GDP printing at 0.5% on expectations of a 0.1% move, has for now saved the EURUSD and the futures. Why the growth: according to the German statistics office, net trade drove 1Q growth (thank you weaker EUR); domestic consumption rose in 1Q while investment declined in 1Q. The sellside community was quick: "Germany’s 1Q numbers show how EMU’s biggest economy is weathering debt crisis", Newedge said in a note. Then there was everyone else: Italian GDP contracted by 0.8%, more than consensus of 0.7%, the most in 3 years. Broadly, the Eurozone GDP avoided a technical recession with GDP printing at 0.0% on estimates of -0.2%. But as the PMI vs GDP chart below shows, this razor thin escape will hardly be repeated in Q2. Greek GDP declined by 6.2%, Portugal down by 0.1%, Holland down -0.2%, and so on. The well known split in Europe between Germany and everyone else continues, and just as we pointed out yesterday for the US: any "decoupling" is always temporary, and eventually catches up with the decouplee. Finally, proving that not all is well even in Germany, the ZEW Investor Confidence for May printed at nearly half expectations of 19, or 10.8, and down from 23.4.

Europe's story today was multi-month record deterioration in equity and credit markets. The turning point appears to have been the market's recognition of what LTRO really is and LTRO2 pretty much marked the top. While recent weakness has been exaggerated by the JPMorgan debacle (contagion to 'cheaper' hedge indices in credit), the Greek reality and clear contagion of a Euro / No-Euro decision any minute has Spanish, Italian, and Portuguese equity and credit markets crashing lower (from already Tilson-clutching lows). Spanish bond spreads are 160bps wider since LTRO2 and Italy 87bps wider with today's +28bps in Spain taking it to all-time record wides (pay less attention to yields now as they will be flattered by the ripfest run to safety in bunds), Portugal is back above 1100bps in 5Y CDS, but most critically - given LTRO's unintended consequence of encumbering the weakest banks exponentially to the domestic sovereign - the LTRO Stigma is up more than 200% from its lows when we first pointed out the reality. Banks who took LTRO exposure are on average almost at record wides (with many of them already at record wides). European equities are weak broadly but remain above their credit-implied levels as investment grade and high-yield credit in Europe falls back to four-month lows (almost entirely eradicating the year's gains) while the narrower Euro Stoxx 50 equity index is down significantly YTD. short- and medium-term EUR-USD basis swaps are deteriorating rapidly once again as clearly funding is becoming a major issue in the Euro-zone.

While gold is now negative year to date in dollar terms, it remains 0.7% higher in euro terms. Gold prices dropped 3.7% last week and silver fell 5.1% to $28.89/oz. The smart money, especially in Asia, is again accumulating on the dip. Demand for jewellery and bullion in India has dipped in recent weeks but should resume on this dip – especially with inflation in India still very high at 7.23%. Also of interest in India is the fact that investment demand has remained robust and gold ETF holdings in India are soon to reach the $2 billion mark. This shows that recent gold weakness is primarily due to the recent bout of dollar strength.  Morgan Stanley has said in a report that gold’s bull market isn’t over despite the recent price falls. Morgan Stanley remains bullish on gold as it says that the ECB will take steps to shore up bank balance sheets, U.S. real interest rates are still negative, investors have held on to most of their exchange traded gold and central banks are still buying gold.

Unbelievable.

That is the only way to express this author’s utter bewilderment that former Federal Reserve chairman Alan Greenspan is still given an outlet to speak his mind.  Actually, I am surprised Mr. Greenspan has the audacity to show his face, let alone speak, in public after the economic destruction he is responsible for. It was because of Greenspan, of course, that the world economy is still muddling its way along with painfully high unemployment.  His decision to prop up the stock market with money printing under any and every threat of a downtick in growth, also known as the Greenspan Put, created an environment of easy credit, reckless spending, and along with the federal government’s initiatives to encourage home ownership, the foundation from which a housing bubble could emerge. It was moral hazard bolstering on a massive scale.  Wall Street quickly learned (and the lesson sadly continues today) that the Federal Reserve stands ready to inflate should the Dow begin to plummet by any significant amount.  Following his departure from the chairmanship and bursting of the housing bubble, Greenspan quickly took to the press and denied any responsibility for financial crisis which was a result in due part to the crash in home prices. 

With the Greek tempest-in-a-teapot about to hit Whale-size, as Tsipras says he will not join the coalition and Venizelos says that Syriza's participation is a prerequisite (via Bloomberg), it seems now would be an opportune time to look forward (not backward at the GGB2s dropping below EUR17 for the first time ever!). As we were among the first to state that their would be a second (if not more) election in Greece, we look at the schedule of events in Europe over the next few weeks (including the payments due on the PSI holdout bonds), and discuss the scenarios and consequences of a Greek exit (for both Greece living without Euro support and the Euro-zone coping with a Lehman-event).

Oh yeah..... Greece.

The ESM funding idea is really just Spain playing for time (the ESM doesn’t actually have the funds to bail Spain out). But the fact that Germany is now making the ESM a political issue indicates the degree to which political relationships are breaking down in the EU. And once the political relationships break down... so will the Euro.

All yopu need to read.

The implications of a nation leaving the Euro (and its contagion effects) are becoming clearer but are by no means discounted by the market. The risk of an interruption in the Greek adjustment program has increased significantly - and as Goldman notes - is the most likely eventual outcome for Greece and fears of the missed interest payment in June continue to concern many. The tough decision and dilemma for the international community remains between a rock (of acquiescence and just funding a belligerent member state) and had place (ECB deciding to let Greek banks go) with an odd middle ground seemingly the most likely given Europe's tendency for avoiding the hard decisions. There is no doubt that the near term implications from such an unfortunate turn of events would be profound for markets; fiscal risk premia would widen, the EUR would decline in value and European equities would underperform. The true question though, is how much lasting damage such a situation can do and whether, in the long run, systemic risks can be contained. In principle, to the extent that no other country chooses to go down the same path as Greece, there is no political or practical hurdle for the ECB to crucially safeguard the stability of the Euro area with unlimited liquidity provisions. A liquidity driven crisis can be averted in that sense. Whether risk premia stay on a higher tangent after such an event is a separate and complicated question but game-theoretically it strengthens the renegotiating position of Ireland, Portugal, and obviously Spain with the ECB (and implicitly the Bundesbank) being dragged towards the unmitigated print-fest cliff.