Is Europe's Exodus Nigh?

By: Submissions

InformedTr​ades writes: Is the Exodus for Euro project indeed nigh? Anti-bailout voices have vehemently espoused so but there are two sides to every coin (or drachma). The fundamental picture hasn't changed by a great deal since I started writing about Europe's extreme pilgrimage through fire and brimstone. However with the passage of time and the very recent rhetorical jawboning and haranguing, the schism between the world's delusional make-believe and reality has shrunk; the gap is being bridged further by fast paced developments in the political arena of Greece and France, serving as a catalyst for the truth.

Reality was always there, it was merely the market's stubbornness and perhaps idiocy that alluded it to the facts and allowed participants to be massaged with alot of hot talk by the Eurocrats and overly optimistic chaps who like to believe that all is very well. Although the fundamental synopsis remains very much grounded in a decade's worth of bad policy, the markets will choose to act it out in different ways, and quite creatively indeed. There have been frequent interludes; but they serve as mere distractions. These interludes were namely the ECB's LTRO in December 2011 and late January 2012, and the Greek PSI operation which placated most global risk markets. Now that the markets have had a fair share of a breather, the big bear is back and with rage.

Just last week, the world was supposedly rather hampered by the center-left electoral results of France and a political stalemate in the Greek parliamentary theater. I discussed about the implications of this electoral outcome and likened it to a grey, rather than a high contrast black & white event. It seems I was wrong (at least as the week progressed and intraday vol was spread further out); European equities, credit, the Euro, European iTraxx Crossover at record wides for 2012 (similarly for the 5Y Spanish CDS)... I could go on forever. Last week was a very bad week for most long-only equity funds in Europe. America was rather shielded from the directional carnage in Europe with obvious intraday European Pre/Post close oscillations which should raise more than an eyebrow as to what, not who is actually trading in American stocks. Global market have been hit once again today and Europe is in a sea of red pixels. Why?

Were the anti-bailout, anti-fiscal consolidation (a sleeker term for austerity) mandates of France's newly elected president the primary catalyst? Did this lead to a long squeeze and capitulations of overly sanguine positions? It really seems so but we will never know. What is certain however is that the market has run out of hopium (for things to settle down in Europe or for more extraordinary central bank stimulus/print fests/backstops).

To wit, most risk-inverse assets are deep in the green, some are even at 2012's best levels. As of today (1000 EST): 10Y TSYs @ 1.77% (-7bp), 10Y Bunds @ 1.43% (-8bp & the lowest yield on record), 10Y JGBs @ 0.85% (-1bp), 10Y Swiss @ 0.54% (-7bp & best performer for the day).

And the bad sovereign debt? 10Y GGB2 @ 26.27% (+255bp /sic), 10Y BTPs @ 5.71% (+23bp), 10Y Bonos @ 6.22% (+26bp & highest in 2012). 10Y CACs are up 3bp at 2.82%.

Spain nationalized Bankia (one of the biggest banks in Spain & a consolidation of 7 community banks 6 quarters ago), buying up 45% of its equity. A shatter to any residual confidence/hope left in Spain's cajas' and large banks' abilities to recapitalize without external assistance (be it from the government or from the Troika). Total non-performing loans are unsurprisingly at a historical record and some speculate that a paltry circa 20% of all delinquent corporate loans and real estate mortgages have been written down. In other words, it is quite a bottomless pit for these banks because they would be essentially bankrupt the moment they mark these bad assets to the market's harsh reality. I noted Greece was a gone basketcase. Spain may soon get that title if nothing continues to be done. I guess it is only a matter of time before the deathknell for Spain is sounded. When that happens (10Y BTPs above 7%?), expect liquidity to be created on a draconian scale. Forget €1trn, Europe would need twice that just to stem contagion.

And if the ECB doesn't print? Well then Germany foots a huge portion of the charity, pardon bill. Talk about China saving Europe with its $2trn in Forex reserves is just ludicrous. 1) To fund Euro liabilities, China would have to sell a good portion of its US TSY holdings, thus shooting itself in the foot; and 2) China understands the risks that its contributions may NEVER be repaid if any nation chooses to renounce Euro denominated debt. The Chinese aren't that dumb. Also notice that Asia has relatively little to do with Europe? The same can be said for America. It seems the world's 'firewall' to Europe's direct toxic sludge is paradoxically not to be financially involved in it (heck, America didn't contribute a cent to the IMF's recent global fund raising tour). Alas, we aren't immune to Europe's cold.

So why do I question about Europe's Exodus? Basically because the path of least resistance and pain is to exit the Euroarea (hence de-legalizing the use of the Euro currency) and not years/decades of depressionary doldrums. But haven't I written about this for the umpteenth time? The catch: Greece seems to be moving along that path, a stark notion a few weeks ago. The second catch: Defacto God, Germany is loosing coercive power over the periphery sovereigns. Merkel suffered her largest 'loss' since WWII after her CDU conservative party scored a measly 26% (falling from 35% in 2010) in the North Rhein-Westphalia state election yesterday. Germany has already lost the full-fledged support from France despite Merkel claiming that she could turn Hollande back to the glorious light of forming a fiscal compact. With two distinct actors going in polar opposite directions as they did 5 weeks back, a shakeup seems prescient. Once the political impasse is complete breached, I reckon the Exodus out of the Euro currency can commence.

The MSM and various financial blogs (and yours truly!) have been questioning whether Greece will exit the Eurozone. As such I wouldn't place too big of a bet on this possibility right now. Regardless of the sometimes senseless monkey-see-monkey-do elocution by the new wires, such utterance can sometimes be condensed into a "yes, but not now" reply. Greece is without doubt the wildcard because its parliament is currently in a 'neutral' position. Remember New Democracy (top voted party) announced its failure to form a coalition one day after it was granted permission. Just today, Syriza (the far-left and second top voted party) also announced that attempts to form a coalition have failed (despite talks with PASOK making some headroom over the weekends). Greece will this likely hold another election. I leave you to speculate on the results (whether you think anti-bailout or serfdom ad infinitum will garner more reception).

Note: All parties are flawed in their own ways. Take Syriza for instance. They may be radically opposing to austerity and staying in the Eurozone but it doesn't offer a ruck of a pragmatic solution to the fallout. It applies for Hollande... and for US president hopefuls. I feel politics is almost always a grey subject as there is no one size fits all solution to the grand scheme of issues.

Another anecdote: €450mn of foreign law GGB1 matures tomorrow (15 May). If Greece fails to pay, CDSs trigger and another mountain will be made out of a molehill, again.

I might have over simplified things here; because even after a currency is de-legalized in a sovereign nation, it needs to introduce a new currency or adopt a currency of another sovereign nation. What happens to all existing debt denominated in Euros? What happens to all bank deposits? Will foreign held assets have to be repatriated before the transition? There are tons of other factors to consider just so anyone thinks it's as simple as smearing mortar on a brick. We're going to be in a surreal game of Charade in the coming few weeks/months but the focus would ubiquitously still be on Europe, America and China.

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