It appears that the markets are in for some action next week. The EU
leaders have pledged to put a package of measures on the table for the
market to absorb by Sunday evening.
There are no details of what may be coming as of yet. This is happening so fast that I doubt they actually have a plan. What plans they will come up with are all going to be short term fixes for the excessive volatility we have seen.
We know from an article by Jon Hilsenrath at the WSJ that the US Fed has opened existing swap lines to the ECB. This means that intervention in the currency markets is coming. I wrote about this last week. My thinking is the same today. If the ECB has a “Go it alone” plan to intervene in the FX markets it will not work for long. Only coordinated intervention including BOE and the US Fed will have anything but a short-term impact. Therefore it is critical to see who is going to be involved come Monday.
There a number of news leaks that suggest that a Euro 600 billion emergency lending facility will be put in place to support Europe’s 1,000 banks that are in need of some “Fast Cash”. This is terrible news. This just confirms that those same banks were facing a liquidity crisis at week's end (AKA- A run on the bank). While E600b is a big amount of money it is a drop in the bucket when it comes to the total funding requirements in Europe. The question will quickly arise, “What happens when the 600B is gone?” This is quite different from the TARP approach where equity was thrown at the banks. That equity had a 10-15X’s leverage affect. This is just a new funding source. It does nothing to address the quality of the assets being funded.
What is missing from the leaks from the EU is a plan to buy distressed sovereign debt in the public market to absorb the excess supply and beef up prices. We know there is pressure from the Banks to have this happen. They are sitting on underwater sovereign bonds. These are public securities with a massive float. I don’t think the ECB has the resources to make much of a dent in the bond market. It is much bigger than they are. If they drive the prices of sovereign debt higher it is likely that they will get offers for more than they could possibly buy. There may be some demand from global investors for Spanish debt at 6%; there will be no private demand if the rate is artificially set at 4%. The higher they drive up bonds the more sellers they will meet.
On the issue of buybacks one has to ask, “Where will they get the money?” A credible buyback would have to start at Euro 500b. Is Germany going to backstop that? I can’t believe that they will. If they do, their debt cost will just rise and nothing will have been accomplished. My worst fear is that in order to finance the buy ins they look to the Federal Reserve Bank in NY to provide dollar based funding.
I don’t think that America has yet woken up to the fact that our share of the Greek bailout is ~$20b (via the IMF quota). When we learn that the Fed is funding Europe with big money there will be a backlash. The Fed is already in hot water for their easy money policy. A $500b loan to Europe by the Fed will not go over too well with the folks in America. If something like this were agreed to over the weekend and we wake up on Monday with a new bailout there will be a very sharp reaction. Several in D.C. (Grayson) will attempt to stop it. Bernanke understands this, Geithner does as well (maybe). A new Marshall Plan for Europe is simply not in the cards. If that is what is attempted it will fail miserably. The most likely outcome will be that the US is rapidly sucked into the European sovereign debt crisis.
There is some very clear anger being voiced from the leaders in Europe. French President Sarkozy stuck his foot deeply in his (mouth) on Friday night with these words:
“We will confront speculators mercilessly. They will know once and for all what lies in store for them.”
In my view this was a stupid move. He is saying, “Come on speculators, I will take you all on and crush you!” He has not one chance in a 1,000 to achieve that. His words prove that he has no idea what he is talking about. This not a matter of evil speculators and their evil tools (CDS). This is about massive fiscal imbalances that everyone understands are unsustainable. Borrowing more to fix the problem will be the end game for Europe.
It is likely that as a result of what will be forthcoming there will be some very big swings in market prices on Monday. The Vol. will be going up, not down. The initial result will, no doubt, be a backup in many markets. The Euro will be higher, European sovereign bonds will trade higher; maybe even equities could catch a bid. But the critical question will be, “For how long?” Depending on the resolve of those in charge this could last for a bit. At least a week and more likely a month. But it is doomed to failure. Should we get to June and the benefits of these emergency steps wane there will be yet another crisis. The bonds will fall again as will the Euro. When that happens there will be no second bailout. Sometime in the next two months we will hear that great sucking noise again. And when it is heard there will be no stopping it.
Get your seat belt on speculators. You are about to be attacked. This will be a lifetime opportunity to make money. For investors, stay clear of this. There is nothing but risk and downside. “Risk off” is the right place to be if you don’t have a helmet on. I can’t wait.