With the Euro crisis having spread across Europe, Germany is now starting to feel the pain. Markets have been cheering the Spanish bank bail out lately, but what is Germany facing this autumn? From Spiegel online.
The German economy will stagnate by this fall because of the euro crisis, Hans-Werner Sinn, president of the Munich-based Ifo Institute for Economic Research, said recently. The Macroeconomic Policy Institute (IMK) sees the German economy stagnating both this year and next. “The crisis in the euro zone, the strict austerity policies and the associated recession in many EU countries” have taken hold of the German economy, says the IMK. The economists at Citigroup expect a recession in the euro zone in 2012 and 2013.
On the contagion effects in Europe. By Voxeu.
“Contagion” is today’s buzzword (de Haan and Mink 2012, Manasse and Trigilia 2011).
- The troika’s bailout of the Greek government and the heavy haircut imposed on private bond holders have failed to reassure markets about Greece’s permanence in the Eurozone.
- The relief brought about by the recent election results waned in a matter of hours.
- Similarly, the decision by the EU to pour about €100 billion into Spanish banks has not proved sufficient to convince investors that the umbilical cord between the State’s and the banks’ balance sheets have been severed.
- In the meantime, confidence on peripheral sovereign bonds and banks has been crumbling, as interest rates and CDS spreads rose in the past weeks.
While proposals for a banking union, Eurobonds (Manasse 2010) and fiscal union still belong to the realm of dreams (or nightmares, depending on who should be footing the bill), the question is whether the flight out of Europe’s periphery will become a flight out of the euro full stop.
As we have been arguing for over a year, a Greek default is inevitable. The question is how to perform it. With the Troika, IMF, ECB, EFSF etc involved, things are rather complex. Peter Tchir gives some color on the subject.
Europe continues to fight the wrong battle, and continues to spread contagion risk.
It is clear that Greece has had a solvency issue now for over 2 years. The ECB and Troika chose to treat it as a liquidity problem. Maybe, they could have argued that in early 2010, but by the summer of 2011 it was obvious to any credit observer that the problem was solvency, yet they continued to treat it as one of liquidity. That is scary because if they feel to see the problem correctly now, they will fail miserably. Not only is the problem clearly solvency, but now forced currency conversion has been added to the mix. Any “solution” from the EU must now address that risk, and it is not the same as solvency. Programs that can protect against solvency may do nothing for the redenomination risk.
Not only did Europe fail to address the problems, but in spite of convincing themselves that all these programs prevented contagion risk, they actually ensured contagion risk. That contagion risk, that they forced on themselves is now coming back to haunt them, and must be carefully addressed in any policy “solutions”.
Two Years of Bad Policy Have Created a Situation Like No Other
There is a lot of talk about what a Greek exit would or wouldn’t look like. People are comparing it to other defaults and currency devaluations. They are wrong. Greece is now unique in that almost all of the debt is owed to institutions that normally step in after devaluation. Greece is also unique in that it is leaving a currency union that is already fragile, and being the first to leave will open the floodgate of speculation as to what other countries will leave.
Guest post by Louis Copper of BGC.
If you really want to know what investors are currently thinking, then move away from looking at equities, and turn your attention to government bond markets. These are showing quite clearly that fear is returning. Investors are fleeing for safety and demanding a high price for taking on risk. So today Germany has sold E4.21bn of two year notes at record low yields – at an interest rate cost of just 0.14%. As Journalist Graeme would say “Wowser”. And it comes only eight days after Switzerland sold two year notes at a record low interest rate of negative 0.251% (investors are willing to lend Switzerland more money than they will get back because they so want the safety of the Swiss government). At the same time, borrowing costs for the troubled Eurozone countries are rising fast. A week ago – last Wednesday – Italy sold 361 day bills at 2.84%, more than double the previous rate of 1.405% at an auction in March. And although the Spanish debt auction yesterday is being taken positively (because it managed to sell more debt than anticipated) Spain paid a price for this – again the interest rate was around double that of the previous month. A good test of investor’s confidence in Spain will come tomorrow with the sale of ten year bonds (the boss of the largest bond investment fund in the world, PIMCO’s Bill Gross, said that anyway Spanish bond auctions are mostly sold to Spanish banks – there are few other buyers). However despite rising fear, we are not yet at crisis yet, with 10 year yields on Spanish and Italian debt still 1-2% below the unsustainable 7-7.5% yields of last Autumn. So when will the next crunch come? When will even the local banks in Italy and Spain refuse to buy their own countries debt?
One of the hot words last year we learnt of was Contagion. Many have used it to describe the possible spill over effects from the Greek mess, but few have actually studied the “real” implications and effects on stock and bond prices. Time for some empirical research, by Mink and Haan;
Using an event study approach, we examine the impact of news about Greece and news about a Greek bailout on bank stock prices in 2010 using data for48 European banks. We ﬁrst identify the twenty days with extreme returnson Greek sovereign bonds and categorize the news events during those daysinto news about Greece and news about the prospects of a Greek bailout. Our ﬁndings suggest that only news about the Greek bailout has a significant eﬀect on bank stock prices, even on stock prices of banks withoutany exposure to Greece or other highly indebted euro area countries. News about the economic situation in Greece does not lead to abnormal returns in bank stock prices.
Markets have been selling off for the past 30 minutes. Renewed fear of the Italian disease is spreading in Europe. Italian spread spiking higher, banks shares selling off aggressively, while the yield curve is inverting. Just as we wrote earlier this weekend, “Italy’s problems are not solved by Silvio resigning”. The Euro is trading close to 1,35, while the MIB index has fallen 6,2% compared to yesterday’s highs…With volumes rather light, expect volatility to stay high, as no “serious” investor can manage to hedge effectively. Important charts below.
Great Market summary, by one of few “free” thinkers, Mr Hussman of Hussman Funds.
Among the effects of the recent and now renewed credit strains in the global economy is that investors have lost touch with relative magnitudes. For example, a billion dollars effectively represents about $3.20 for every adult and child in the U.S., while a trillion dollars represents about $3,200 dollars per person. From our standpoint, among the most important research coordination that government provides comes from the National Institutes of Health (NIH), which funds basic medical research in cancer, diabetes, multiple sclerosis, Alzheimer’s, autism, and other conditions, and where the total annual budget is about $31 billion annually (roughly $100 per American). Add in just over $7 billion in research through the National Science Foundation, and about $120 per citizen a year is spent by the government on essential medical and non-military scientific research through these agencies. These figures pale in comparison to the amounts that are increasingly demanded in order to make bondholders whole on their voluntary, bad investments. The Federal Reserve provided an amount equal to the entire NIH budget simply to backstop the rescue of Bear Stearns, which allowed Bear Stearns bondholders to receive 100 cents on the dollar, plus interest. In return, the Fed got questionable assets that it pouched into a shell company called “Maiden Lane,” which were later reported to have “underperformed.”
“Everyone needs the ECB to step up to the plate. The ECB has no excuse not to act. In trying to keep its monetary virginity intact, the bank threatens to de- stroy the Euro Zone. If that happens, nobody will be able to profit from its virginity.”
– PAUL DE GRAUWE
“Simple Math: The total overall cap [of the ESM] is 500 billion Euros 160 billion Euros has been spent
340 billion Euros remains 340 billion Euros + zero Euros = 940 billion Euros”
– Mike Shedlock, on the latest European ‘Masterplan’ to merge the EFSF + ESM
Full must read report Hmmm October 23
As Trichet is speaking, and HFT listening, markets move as usual on no volume, where the speed of light is determining bid/offer spreads. Before considering buying this no volume melt up we have witnessed lately, please review some of the news Trichet is delivering.
*ECB’S TRICHET SAYS CONTAGION THREATENS FINANCIAL STABILITY – BLOOMBERG
*TRICHET SAYS LIQUIDITY AND FUNDING RISKS ARE `HEIGHTENED’ – BLOOMBERG
*TRICHET SAYS EURO CRISIS HAS REACHED `SYSTEMIC DIMENSION’ -BLOOMBERG
And the reaction….