Kicking The Can Down The Road

By Nic Lenoir Of ICAP

Well it seems that at last Europe is embracing currency debasement, unless the parliament decides on a final insult to injury and turn down the package proposed by the ECB/IMF French dynamic duo Trichet/DSK. The choice was slim with contagion raging.

No help means an inevitable downgrade by Fitch of Greece (at 20% 2Y borrowing rates like we saw this morning refinancing is impossible, there is no way out) which in turn renders Greek bonds inelligible for repo at the ECB facility. Who are the holder of Greek bonds? European banks of course, especially French ones. Then obviously the same happens for Portugal, Spain, and the entire banking system in Europe collapses.

Reality finally hit in Europe despite Mr. Almunia's claims that there are no default in the Eurozone that you are as solvent as you can roll your debt. The ECB and the IMF will therefore put their balance sheets on the hook to get Greece out of this impass. Of course one needs to look past Greece as the other Southern countries are going to require the same kind of help, and if they dont do it by themselves the market will probably do it for them in due time. The path is slippery because there is never a good time to default. With austerity required very unlikely to be attained no doubt that these countries will be back for more and then some, and could at some point force the countries helping them into a tough spot. France is not short of unaccounted for social entitlement programs, and Germany can't seriously bail out everybody. It might be worth starting to look at the debt/GDP ratio for the entire eurozone if we go that route as it will dictate, if this plan works, when nervousness will return down the road (where the can was kicked after so much drama).

We have been convinced core shorts of EURUSD since 1.51 and 1.4870 and we think this trend is far from having run its course. Another trend may well be in the process of acceleration: Gold's! We had our initial buy recommendation in the 1,080/1,090 zone and ever since 1,135 we got confirmation the move could have a lot more legs. We retested that support recently and we think the environment is now ripe for further acceleration, barring Congress banning completely commodities speculation via OTC products and ETFs. This caveat is important as it is an agenda being seriously pushed forward and an exogenous shock that the bull market in Gold could not digest. But without this ultimate governmental manipulation scheme, with the Fed reiterating its "extended" accomodative policy and the ECB throwing the fiscal responsibility towel, there is nothing to stop a run up in Gold. The fact Gold actually appreciated along with the USD index during this latest Greek panic if it indicates a change in correlations is very telling.

The financial reform bill has the potential to be disastrous because if the agenda to eliminate private speculation in commodity markets prevails, then liquidation will be violent given the recent flows of money towards these markets. Maybe it is the government's final answer to deficit worries: if you force people out of commodities, they will have to support equities and bonds, and given the risks to growth and earnings priced in by equity markets, it means the US Treasury no longer has to worry about demand at auctions or a weak currency generating commodity inflation. It would be the final insult and nail in the coffin for what is left of our capitalist system. It was brought to my attention that national security concerns have been supporting this agenda, and that is a point well worth keeping in mind. It would certainly buy the US 10 more years of additional time to reach energy independence. Be very cautious though, bank stocks would take a strong hit, and so would energy companies.

Bunds have it a strong resistance and while we expect some consolidation around these levels we feel a great shorting opportunity is presenting itself if it is indeed confirmed that Germany is giving up its balance sheet. Our initial target on the upside was 124.85, but in the panic the market made an excess yesterday. Ideally we get a retest of 125.20 to enter short positions thoug a final resolution must be fully approved at this stage for the market to really factor balance sheet dilution given the political roller-coaster it has been.


US Treasuries are probably still stuck in that 114-119 range and don't really present the same opportunity here. The curve is likely to steepen given the Fed announcement and yield expectations in the long, but with the Treasury announcing much better than expected tax receipts supply could be reduced and will keep a bid that is more likely to take to the top than the bottom of the range for now.

We see additional downside potential for the S&P future and a test of 1,167/1,1770 as long as the market does not bypass 1,195.



Good luck trading,

Nic