Looking at the growing spat between Germany and France in relation to the on-going European saga, we thought this time around we would use the term "Agree to Disagree", given that the term "agree to disagree" or "agreeing to disagree" is referring to the resolution of a conflict (usually a debate or quarrel) whereby all parties tolerate but do not accept the opposing positions:
When looking at the growing divergence between US stocks and US Bond yields, and softening US economic data, one can wonder our long US investors can "agree" to "disagree" - source Bloomberg:
Bond yields have to reach “an inflection point” before shares can move into what’s known as a secular bull market if history is any guide, Hartnett wrote in a June 12 report.
The CHART OF THE DAY compares the Dow Jones Industrial Average and the yield on 10-year Treasury notes since 1900, as Hartnett did in his report. The yield figures were compiled by Yale University Professor Robert J. Shiller and obtained from his website.
Hartnett highlighted three inflection points in the past century, as shown in the chart. They foreshadowed stock-market booms during the 1920s, after World War II, and throughout most
of the 1980s and 1990s.
A comparable surge in share prices is unlikely, he wrote, “until Treasury yields rise in response to stronger growth and a healthier global economy.” The 10-year yield fell to a record 1.4387 percent this month.
Even so, lower yields are giving investors more incentive to shift into stocks from bonds, the New York-based strategist wrote. He estimated that it will take a 0.6 percent yield for the 10-year’s return in the next 12 months to match stocks’ 20th-century average of 10.5 percent a year." - source David Wilson, Bloomberg, 15th of June 2012.
"Mind the Gap" we indicated on the 8th of May in relation to the European space. European investors had agreed to disagree, we thought at the time, for too long, and now it looks like the gap has been closing. - Top Graph Eurostoxx 50 (SX5E), Itraxx Financial Senior 5 year CDS index, German Bund (10 year Government bond, GDBR10), bottom graph Eurostoxx 6 month Implied volatility. - source Bloomberg:
The current European bond picture with the recent rise in Spanish and Italian yields - source Bloomberg:
Indeed Spanish bond yields have reached "intervention" level for the ECB, with Prime Minister Rajoy pleading for additional support, although the SMP (Securities Market Programme) has been on hold since March, after reaching 219.5 billion euros - source Bloomberg:
As far as Credit Markets were concerned on Friday, it was short covering time, as a European credit market maker put it:
What remains concerning, as we argued in our conversation "St Elmo's fire" on the 26th of May, is that the SOVx index representing the CDS risk gauge risk for 15 Western European countries (Cyprus replaced Greece in March in the index) remains at elevated levels and so does the Itraxx Financial Senior Index, a further indication of the existing correlation between financial and sovereign risk:
As we indicated in our conversation "The Spread Also Rises" on the 24th of March following the credit indices rebalancing:
"Replacing Greece by Cyprus is the SOVx series 7 index might not be enough to preserve the 15 member's number status. On the 13th of March, Moody's rating agency joined its peer Standard and Poor's in slashing Cyprus to junk status on heightened concerns over its banking sector’s exposure to Greece. Only Fitch rating agency has maintained its rating for Cyprus one notch above junk."
On the back of Spain's downgrade, Moody's downgraded 12 Spanish Sub-Sovereigns, 2 Gov-Related Entities on Friday.
No wonder in the current European context, there is such a difference between the Spanish and German sovereign yield curve with a much more flatter German curve - source Bloomberg:
Moving on to the core subject of the future for Europe as we are reaching the end for this extended game of "can kicking", we have been wondering what could make us "agree to agree" rather than continue to "disagree" in relation to our European saga. We think Exane BNP Paribas did a good work in summarizing what is needed to review our negative stance, in their recent note "Crunch time is still not with us" from the 14th of June:
In relation to the ongoing issue of circularity, which we discussed in our conversation "Eastern Promises", it means that correlation between Sovereign risk and Financial risk is different between countries since January 2010 - Spain versus Germany:
Exane BNP Paribas in their note added in relation to the 100 billion euros plan for the Spanish banking sector added:
In order to "agree to agree" with Exane BNP Paribas, we think the possible solution for the Eurocrisis goes through mutualisation, default and Official sector involvement:
Make no mistake, at some point, as our good credit friend put it, losses will have to be taken.
"Europe needs a short term solution before it can consider a long-term one, and the current nature of the short term problem facing Europe is not necessarily one that is addressed by a banking union."
Indeed, looking at the continuous deposits outflows from Greece, European politicians, while continuously agreeing to disagreeing, are once again utterly and completely behind the curve:
If our European politicians had studied carefully what had happened in Argentina before their default in 2002, they would not be pressing for a "Banking Union" but should rather be more concerned about a deposit guarantee scheme if they are "really serious" about keeping Greece in the Euro. Back in March we argued the following in our conversation "Modicum of Relief":
"A liquidity crisis happens when banks cannot access funding (LTRO helped a lot in preventing a collapse). A solvency crisis can still happen when the loans banks have made turn sour, which implies more capital injections to avoid default (hence the flurry of subordinated bond tenders we have seen). Rising non-performing loans is a cause for concern as well as rising loan-to-deposit ratios."
In relation to the similarity of Greece in relation to the Argentina crisis of 2001 leading to its 2002 default, we related to a CreditSights article written at the time of the crisis (CreditSights, 31st of July 2001 paper "Defining the Default Path") :
"the most puzzling aspect of the crisis so far is the relative complacency of the public. This is starting to be tested. The term structure of deposits doesn't bode particularly well, especially as the government has tried to force the banks out longer on the curve than is ideal given deposit withdrawals. We estimate that almost 2/3 of deposits are eligible to be withdrawn in the next 30-60 days and we would be surprised if those deposits that extend in the system were put in time deposits. In addition to the obvious potential of a run on the banks, the lack of liquidity in the system has forced the central banks to provide unprecedented level of repos to the system and also relax reserve requirements. The problem is that this is very unclear whether that additional liquidity is funding anything but capital flight at this point."
As far as Spain is concerned, deposits flights have not yet materially happened:
Following on our pet subject of bond tenders, and pain for bondholders as well as shareholders, we have long been expecting such a pain to materialise:
"First bond tenders, then we will probably see debt to equity swaps for weaker peripheral banks with no access to term funding, leading to significant losses for subordinate bondholders as well as dilution for shareholders in the process." - Macronomics - 20th of November 2011.
Banco Sabadell on the 14th of June offered to buy back 1.6 billion euros worth of preferred shares and subordinated debt issued by CAM, a former savings bank which was acquired by Sabadell in 2011. Sabadell offered to buy back 1.3 billion euros of preference shares issued by CAM and 321 million euros worth of subordinated debt which will be re-invested by investors in newly issued Sabadell shares. Most of these "preferred" shares had been issued to retail clients...
"We believe additional debt to equity swaps will have to happen for weaker peripheral banks, similar to what we witnessed with Banco Espirito Santo in October 2011, as well as for German bank Commerzbank ("Schedule Chicken" - 25th of February 2012)." - Macronomics - Peripheral Banks, Kneecap Recap.
Spain has yet to apply the full extent of the Irish recipe which we discussed "The road to hell is paved with good intentions":"Given the recent outrage by individuals investors relating to the performance of Bankia's share price following its IPO in 2011, it will be interesting to watch the subordinated bond space when looking at the difference in ownership between Ireland and Spain. One has to wonder if Spanish retail investors will be inflicted additional pain..."
Looking at the recent Sabadell "liability" exercise, it looks like Spanish retail investors are bound to be inflicted additional pain. As indicated by Bloomberg in a recent article - "Irish Tell Spain to Imagine the Worst and Burn Bank Bondholders":
"In all, subordinated bondholders suffered about 15 billion euros of losses in Ireland, helped by the direct or threatened use of the new laws, due to expire this year.
Spain may be reluctant to impose losses on holders of junior debt. Bankia Group is among Spanish lenders that sold 22.4 billion euros of preferred stock to individual investors through retail branches, according to data compiled by CNMV, the financial markets supervisor.
Because of capital structure rules, these investors should be wiped out before losses are imposed on junior debt holders, a move Spanish Prime Minister Mariano Rajoy’s government may shy away from unless he introduces laws to protect them."
Unless our European politicians rapidly introduce European laws guaranteeing depositors money ("insurance for depositors against the risk of euro exit" is qualitatively different from "deposit insurance"), capital flight might start in Spain as it has already in Greece.
"It should also be noted that for the ECB to guarantee the Euro deposit base against redenomination risk is not necessarily as radical a policy as it might seem; really, all it amounts to is a guarantee that the Euro will function as a currency union. This can be seen through a thought experiment." - Exane BNP Paribas
CreditSights in their article relating to Argentina clearly indicated the dangers of deposit outflows. While complacency is prevailing so far in relation to Spanish deposits, it cannot be taken for granted, as shown by the situation in Argentina which quickly spiraled out of control and led to its default in 2002:
"the most puzzling aspect of the crisis so far is the relative complacency of the public. This is starting to be tested." - CreditSights, 31st of July 2001 paper "Defining the Default Path".
Clearly while our European politicians are continuing to "Agree to Disagree" the clock is ticking on the Doomsday European device. As Exane BNP Paribas put it, our European politicians need to come fast with the defusal kit:
"How to defuse a nuclear bomb:
Managing such a crisis would require the ECB to carry out policies which differ by orders of magnitude from anything it has attempted so far. As we noted in an earlier section, a deposit insurance scheme cannot guarantee the entire deposit base against redenomination risk; this is another example of the general principle that a basically fiscal entity cannot do the work of a monetary authority. Furthermore, in a case of a run motivated by fears of euro exit, the guarantee required could not realistically be restricted to the insured deposit base. Even for Greece, the total deposits (domestic NFCs and households) total EUR160bn; for Spain the liability would be EUR714bn and for Italy EUR1trn. Clearly, the only body that could credibly backstop a guarantee to pay depositors the Euro value of their euro-denominated deposits would be the ECB."
On a final note, as indicated by Bloomberg Italy could rapidly come back in the spotlight, should European politicians fail to stabilise Spanish woes: "Italian corporate and household bad debt, totaling a combined 107.6 billion euros, is more than 65% higher yoy while remaining stable ytd. Spain's reported bad debts total 148 billion and have risen 6% in 2012, driven by construction and real estate. Italian corporate and consumer bad debt will likely rise should contagion fears spread."
"Politics is not the art of solving problems, but to silence those who ask. "
"There is no problem urgent enough in politics that an absence of decision cannot resolve."