Ireland

That red color on your screen this morning is not a failure in the green pixel channel but an indication of three main things. First, European composite PMIs came in at 49.3, down from 50.4 in January, and below the preliminary print 49.7 released on February 22. The main reason was the slide in the Eurozone Service PMI which printed at 48.8 on expected 49.4. This included a deterioration not only in the peripheral countries but in the core stalwarts France and Germany too. Elsewhere, China reduced its growth target to 7.5% this year, the lowest goal since 2004. The government will also aim for inflation of about 4 percent this year, unchanged from its goal in 2011. China also announced that it will target a deficit of 800bn CNY for 2012, a rather surprising change from its previous stance. Rounding out the dour note is a Moody's announcement that Ireland is likely to need a second bailout when its current aid program ends, rating agency Moody’s warned today, and that it too may need a PSI just like Greece. Then again, scratch may and replace with will. From the Irish Times: "In its weekly credit outlook report, Moody’s also warned a No vote in the upcoming fiscal treaty referendum would bar Ireland from receiving further funds from the European Stability Mechanism (ESM). The agency predicted the Government would have to rely on the ESM for additional funding after the existing bailout program expires in 2014. "We expect Ireland to face challenges regaining market access in 2013 and it will likely need to rely on the ESM, at least partially, when the current support  programme expires,” it said." As a reminder, if Ireland proceeds with a referendum on the Fiscal compact, and the referendum fails, it will have no ESM support, and thus no second bailout potential. Finally, the ECB deposit facility usage soared to an all time record of €821 billion overnight, confirming that the LTRO 2, contrary to some wrong analysis, is not being used for Carry trades at all.

The situation in Greece should create some big headlines this week. The bond exchange “invitation” is set to expire at 3pm EST on Thursday March 8th. This is the so-called Private Sector Involvement or PSI. Greece has other steps to take during the week, and ultimately the Troika will determine how to proceed with the bailout, but not until the results of the PSI are known. It could be a week of confusing, misleading, and market moving headlines. Figuring out the “proper” reaction to each bit of news will require understanding the terms, and hoping the headlines are accurate – which given how confusing the situation is, cannot be fully counted on. Remember, the original “invitation” from the Greek government was for an amortizing bond, which was then changed to a series of 20 “bullet” bonds, so the level of confusion remains high.

Back in October, when Greece was rewarded with further bond haircuts for progressively missing its economic targets, even after having gotten caught on at least one occasion making its economy appear worse than it was, we said that it is only a matter of time before "Portugal, Ireland, Spain and Italy will promptly commence sabotaging their economies (just like Greece) simply to get the same debt Blue Light special as Greece." In the aftermath of this statement, we got the Irish and the Portuguese proceeding to slowly but surely do just that. Today, it was Spain's turn to make it 3 out of 4 after as Reuters noted so appropriately, "Spain defies Brussels on deficit target" clarifying that "Spain set itself a softer budget target for 2012 on Friday than originally agreed under the euro zone's austerity drive, putting a question mark over the credibility of the European Union's new fiscal pact. Prime Minister Mariano Rajoy insisted he was acting within EU guidelines because the plan was still to hit the European Union public deficit goal of 3 percent of gross domestic product (GDP) in 2013." That Italy is sure to follow is absolutely guaranteed, however just because the ECB is now indirectly monetizing BTPs the true impact will be delayed far more, and instead of taking prompt steps to remedy the situation, the European complacency will be accentuated by the fact that bond yields are very low, and supposedly indicates the true state of the economy. No. All it indicates is the conversion of future inflation (courtesy of €1 trillion in new money in the past 3 months) for a very temporary respite before all hell ultimately breaks loose as countries pretend everything is ok as bond yields are pushed artificially low. And in doing nothing, the fundamentals in the economy only get worse and worse. Germany knows this very well, and the Economist explains the reaction to Spain's surprising statement today perfectly...

Back in September, before the transition from then ECB head J.C. Trichet to current Goldman plant and uber printer Mario Draghi we asked whether "Trichet will disgrace his already discredited central banker career by pushing a rate cut before he is swept out of the corner office by Mario Draghi, or will the former Goldmanite Italian become the most hated man in Germany soon, after he proceeds to ease, even as Germany still experiences Chinese inflationary re-exports. The answer will be all too clear in just a few months." Sure enough, following a whopping €1 trillion in incremental liquidity released by the ECB in the three shorts months since Draghi's ascension on November 1, all under the guise that the ECB is not printing when it most certainly is, albeit "hidden" by the idiotic claim that it accepts collateral for said printing (what collateral - Italian and Spanish bonds, which will become worthless the second even more printing is required in a few short months? This is run time collateral that can be issued "just in time" to convert it to even more cash as UniCredit did again today), the answer is becoming clear. Slowly but surely the realization is dawning on Germany that while it was sleeping, perfectly confused by lies spoken in a soothing Italian accent that the ECB will not print, not only did Draghi reflate the ECB's balance sheet by an unprecedented amount in a very short time, in the process not only sending Brent in Euros to all time highs (wink, wink, inflation, as today's European CPI confirmed coming in at 2.7% or higher than estimated) but also putting the BUBA in jeopardy with nearly half a trillion in Eurosystem"receivables" which it will most likely never collect.

So, yesterday it was revealed that both Goldman and JPM had about 145 billion of “gross” notional outstanding on CDS related to the PIIGS. That means they each had roughly 145 billion of purchases and sales. They spoke about various netting agreements that makes the real number lower. They also mentioned with collateral and on a mark to market basis, the real exposure is far lower. Fine, though I wonder why they don’t execute the “master” netting and get the gross notionals down? Wouldn’t that help the system? If these were cleared or on an exchange, all they would have a single net exposure for each country. The collateral and netting would be handled at the central clearing or exchange. Wouldn’t that be simpler? Safer? The e-mini S&P future contract seems to be able to trade that way just fine, and it is more volatile than CDS on most days. Italian CDS is in 25 bps today – seems like a lot, but the up-front payment to buy or sell Italian CDS has changed by less than 1%.

As the ECB has stopped its SMP bond-buying and now the LTROs are all done (until the next one of course), Portuguese bond spreads have been increasing rapidly and post-LTRO today even more so.  While broadly speaking European sovereign risk is modestly higher this week (and notably steeper across the curve) leaving funding costs still very high for most nations, Portugal has exploded over 100bps wider (and almost 70bps of that today post-LTRO) to back over 1200bps wider than Bunds. Only Italian bonds are better and even there they are leaking back to unch from pre-LTRO. Perhaps, shockingly, more debt did not solve the problem of too much debt and with growth and deficits being questioned in Ireland and Portugal (and Spain), it's clear the newly collateralized loan cash the banks have received won't be extended to the medium-term maturities in sovereign bonds.

• Euro-Area Banks Tap ECB for Record Amount of Three-Year Cash (Bloomberg)
• Papademos Gets Backing for $4.3B of Cuts (Bloomberg)
• China February Bank Lending Remains Weak (Reuters)
• Romney Regains Momentum (WSJ)
• Shanghai Raises Minimum Wage 13% as China Seeks to Boost Demand (Bloomberg)
• Fiscal Stability Key To Economic Competitiveness - SNB's Jordan (WSJ)
• Bank's Tucker Says Cannot Relax Bank Requirements (Reuters)
• Life as a Landlord (NYT)

As US markets hit their all time highs, there is nothing but bad news in EU sovereign land. What does it take for people to understand that equities have detached from fundamentals & the macro outlook?

...European banks are three times larger than the European sovereigns, the ECB is not the Federal Reserve Bank of the United States, the leading economy in Europe, Germany, is 22% of the economy of America, that there are ever and always consequences for providing free money, that Europe is in a recession and it will be much deeper than thought by many in my view, that the demanded austerity measures are unquestionably worsening the recession and increasing unemployment, that nations become much more self-centered when their economies are contracting and that the more protracted all of this is; the more pronounced Newton’s reaction will be when the pendulum reverses course.

There is broad disagreement among European banks on whether they should (and whether they will) choose to access the LTRO. We have discussed the top-down perspective and the very granular bank-by-bank perspective, and we end with a more bottoms-up perspective on the bank's own views of the LTRO. As SocGen notes, the investment banks (and certain Swedish banks) are very skeptical (and rightly so given the 'LTRO Stigma') while the Italian and Spanish are open to taking whatever they can, whenever they can (is that really a good sign?). Bank management must weigh the transparency they will face at the end of the quarter when sovereign bond holdings are exposed and just as SocGen points out, banks with considerably higher exposure (implicitly through the carry trade) may well face much more negative market action (even if Basel III doesn't handicap that risk). As with LTRO 1, the ECB will only reveal aggregate data, leaving the individual banks themselves to reveal their own take-up - we suspect the investment banks will make a point of highlighting that they did not take the funds, while the Portuguese, Italian, and Spanish banks will promote the benefits of their government-reach-around self-immolating ECB life-line.

While the now scheduled Irish referendum on the fiscal treaty, which will likely not pass successfully absent major concessions on behalf of Europe, will not precipitate a failure of the recently agree upon compact, as 12 out of the 17 contracting parties need to support the Eurozone, it will have an impact in that it would impact future bailouts of Ireland courtesy of preset European bailout mechanisms. In other words, should things take a turn for the worse, and they will, in the near future, Ireland will have to rely on itself to save itself. As a reminder, it took Europe 2 years to (supposedly) firewall itself from default and a collapse of its banks. How long will the same take for Ireland, because while the country may be standalone, its banks most certainly will not be. Remember that money is fungible. So are massive unrecognized Mark to Market losses. Morgan Stanley explains.

Just as we scripted, the temptation to migrate from the status quo in Europe was just too high for the other peripherals and Ireland just gained first / next mover advantage by daring top mention the "R" word. As Bloomberg notes:

• *IRELAND TO HOLD VOTE ON EU FISCAL COMPACT, KENNY SAYS

We would imagine that Barroso and his pals are scrambling now that another 'Referendum' is on the cards (and we are checking what 'referendum' is in Portuguese) and while fascism in perpetuity has been priced into Euro, the possibility that democracy rears its ugly head has just sent the EURUSD tumbling.

But coincidentally, the ECB’s next Long Term Refinancing Operation (LTRO) is set for February 29...

Will Germany go “all in” on the Euro experiment? I doubt it. In fact I’ve found the “smoking gun” the little known act that Germany has recently implemented that proves the country has a Plan B that involves leaving the Euro with minimal damage.

With the second version of the ECB's enhanced LTRO (back-door QE) starting tomorrow, there has been a great deal of speculation on what the take-up will be, what banks will do with the funds they receive, and more importantly how will this effect global asset markets. SocGen provides a comprehensive top-down analysis of the drivers of LTRO demand, the likely uses of those funds, and estimates how much of this will be used to finance the carry trade (placebo or no placebo). Italian (25%) and Spanish (20%) banks are unsurprisingly at the forefront in their take-up of ECB liquidity (likely undertaking the M.A.D. reach-around carry trade ) and have been since long before the first LTRO. On the other side, German banks have dramatically reduced their collective share of ECB liquidity from 30% to only 6%. SocGen skews their detailed forecast to EUR300-400bn, disappointing relative to the near EUR500bn consensus - and so likely modestly bad news for risk assets. Furthermore, they expect around EUR116bn of this to be used for carry trade 'revenue' production which will however lead to only a 0.6% improvement in sectoral equity levels (though some banks will benefit more than others), as they discuss the misunderstanding of LTRO-to-ECB-deposit facility rotation. We, however, remind readers that collateralized (and self-subordinating) debt is not a substitute for capital and if the ECB adamantly defines this as the last enhanced LTRO (until the next one of course) then European banks face an uphill battle without that crutch - whether or not they even have collateral to post. Its further important to note that LTRO 2 cannot be wholly disentangled from the March 1-2 EU Summit event risk and we fear expectations, priced into markets, are a little excessive. We suspect this will not be a Goldilocks 'just right' moment.