'Crisis Likely To Get Worse Before It Can Get Better... If Indeed It Ever Does'

Zero Hedge,

25 February, 2011

Deutsche Bank's Jim Reid, who has taken etudes in Mutual Assured Destruction to a level not even Leopold Godowsky would be able to execute (which is expected: DB is the one bank in Europe that has the biggest disconnect between reality and where the market trades its securities) reminds us once again that without the ECB stepping in it is all lost: "We are fast running out of options. The great hopes of the last few weeks for Europe have fallen one by one. We first had China pulling back, then a Levered EFSF scheme that has stalled before it has taken off, a powerless IMF and now yesterday we had even more insistence from Mrs Merkel that Eurobonds are not the answer and neither is a more aggressive ECB. 

It leaves us scratching our heads as to what the answer is." Yet the ultimate step: the questionable integration of Europe's countries in a union whereby they abdicate their sovereignty to Germany in exchange for the issuance of Eurobonds, is not only extremely unlikely, it will also come too late: "Should we get excited ahead of the treaty changes? The answer is that we are undoubtedly slowly moving closer to the start of a path towards fiscal union. However this process, even if it runs smoothly, will likely be a long, drawn-out, arduous journey. Unfortunately markets are moving at a much, much faster pace and we probably don’t have the time for a slow measured path towards fiscal union." 

In other words, even if the ECB, and thus Germany were to relent, the markets can at best hope for a few days rally before risk tumbles off once again, only this time there will be no scapegoats aside from the bloated and terminally broken European bureaucratic engine which, when all is said and done, is the fatal flaw of the European experiment.

From DB's Early Morning Reid

We are fast running out of options. The great hopes of the last few weeks for Europe have fallen one by one. We first had China pulling back, then a Levered EFSF scheme that has stalled before it has taken off, a powerless IMF and now yesterday we had even more insistence from Mrs Merkel that Eurobonds are not the answer and neither is a more aggressive ECB. It leaves us scratching our heads as to what the answer is. The press conference between Mrs Merkel, Mr Sarkozy and Mr Monti ended with us being told that information about plans to change the EU treaty will be announced in the coming days ahead of the December 9th EU summit but it won’t involve changing the ECB’s mandate. The leaders agreed to respect the independence of the ECB.

Should we get excited ahead of the treaty changes? The answer is that we are undoubtedly slowly moving closer to the start of a path towards fiscal union. However this process, even if it runs smoothly, will likely be a long, drawn-out, arduous journey. Unfortunately markets are moving at a much, much faster pace and we probably don’t have the time for a slow measured path towards fiscal union. As a result the crisis is still likely to get worse before it can get better, if indeed it ever does.

The only hope is that there’s enough unity and encouragement in the leaders’ upcoming statements that persuades the ECB that notably upping their bond purchasing is a worthwhile interim measure prior to a fiscal union that they now think is likely.

The market had initially hoped for a tone change from Germany, particularly after the Bild hinted that Merkel’s coalition may be warming up to the idea of euro bonds. The mood quickly reversed after the Trio confirmed that there are no quick fixes to the problems. 

The news also completely overshadowed the stronger-than- expected German IFOs in the morning. The Stoxx600 fell as much as 2% from the highs to close -0.15% on the day. The FTSE (-0.24%) extended its consecutive down days to nine, a run that was last seen in January 2003 where the FTSE dropped 11 days in a row on the back of geopolitical tensions in the Middle East and on signs of economic slowdown in the US. The Stoxx600 Bank index rallied 1% though after having fallen 8 consecutive days. Dexia gained nearly 28% after a French official said that a deal between the French and Belgian governments can be reached within days.

Asian markets are mostly softer across the board as we type. The Hang Seng and the Kospi are -1.2% and -1.3% lower respectively. The market remains on the back foot after Merkel’s continued hard line stance yesterday. Somewhat interesting is the 6bp rise in JGB 10 year yield to 1.025%, the highest in about 3 weeks. The market is perhaps still digesting S&P’s comments yesterday. To recap, the agency said that “Japan’s finances are getting worse and worse every day, every second” and added that “it may be right in saying that we are closer to a downgrade”. Japan’s Sov CDS were +6bp wider overnight at 131/134bp. Elsewhere in credit the Asia IG and the Aus ITraxx are +4bp and +7bp on the day.

In other overnight news, Moody’s has taken the lead to cut Hungary’s sovereign rating to Junk. The rating was cut to Ba1/Neg from Baa3 with the agency citing rising uncertainty around the country’s ability to meet medium term fiscal/debt targets and the rising susceptibility to event risk

Moody’s decision is somewhat at odds with S&P which decided to deferred its decision on a negative action until February pending negotiations between Hungary and the IMF on a financing deal. Hungary is rated BBB-/CW Neg by S&P and BBB-/Neg by Fitch.

Whilst on rating actions Fitch yesterday downgraded Portugal to BB+/Neg from BBB-, on a day which saw an organised strike paralyse the nation’s capital. Portugal’s 10-year yield rose 84bp on what was another difficult day for the EU government bond market. 10-year BTPs closed above 7% for the first time in 6 days. Elsewhere in Europe, Irish 5yr bond yields rose 47bp to 9.62%. The 10yr Bund yield rose nearly 5bp to close at 2.19%. The recent rise in Bund yields has also seen the Bund/UST spread widened to 31bp, the widest since April 2009. Back to Portugal, the agency said the country’s large fiscal imbalances, high indebtedness across all sectors and adverse macroeconomic conditions as no longer consistent with an IG rating. Portugal is rated BBB-/Neg by S&P and Ba2/Neg by Moody’s.