Mario Draghi has promised to do what it takes to save the euro. Markets are doubtful (video) – but the logical conclusion of the European Central Bank boss’s justification for action is that the ECB should be shorting German bonds – Short View column here.
The post-Draghi recovery has stalled. To recap: last Thursday ECB president Mario Draghi said the central bank is ready to do whatever is needed to save the euro, and markets went wild.
The markets are more nuanced today.
- The euro is down (perhaps rationally: if the euro solution is to print money, debasement offsets the continued existence of the currency). Just as important for the technically-minded is that the euro failed to break its 30-day moving average, at $1.237.
- The German 2-year yield has set a new low, coming close to -0.1% before recovering a little. Flight capital, in other words, is still headed for Germany. Longer dated German bond yields remain wider than last week, but are still tighter than at the start of July. There is not much confidence that Draghi will succeed in the face of the Bundesbank’s opposition.
- On the plus side, Spanish yields continue to improve, with the 10-year having now plunged a full percentage point since last Tuesday, and short-dated yields also dropping sharply. Again, though, things remain worse at the end of July than they were at the start.
The two most important eurozone charts after the turn
Humphrey-Hawkins testimony is not always a non-event. Six years ago, Ben Bernanke used his first Humphrey-Hawkins testimony to signal to the market that the steady rise in the Fed Funds target rate was going to end at 5.25 per cent. That seems an impossibly long time ago now, as does the last big surge in the S&P 500 during the “fool’s rally” of the mid-naughties, which that testimony provoked.
Today’s testimony, however, does indeed appear to have been a non-event, as accurately predicted by Mike Mackenzie, deputising for James Mackintosh, in Monday’s Short View:
The line in his testimony that appears to have attracted most attention is that the Fed “is prepared to take further action as appropriate to promote a stronger economic recovery” – it is hard to see how he could possibly have said the opposite. Judging by Twitter, there is also interest in his comment that QE has been “effective” so far but should not be used “lightly”. It is hard to disagree. Some might disagree about the “effectiveness” line, but successive waves of QE have at least succeeded in holding up asset prices and buying time for US banks, which was probably the main intent. Read more
Does Spain really need to leave the euro? There is a pervasive argument that it does. That would restore its competitiveness, and allow the country to inflate away its debts.
But Xavier Vives, an economist at the IESE business school in Barcelona, suggests otherwise. Spain obviously has some serious problems, but an overvalued currency is not one of them. The charts he presents show that Spain’s share of global merchandise exports has barely declined during the eurozone era – quite a feat given that even Germany’s share has declined during the rise of China. Meanwhile Spain’s services exports have gained market share quite healthily. Devaluation would help but it is not desperately needed.
Everyone knows how the dominoes will fall in Europe: Spain, then Italy, then struggling France, stuck with the biggest of big governments, a Socialist president and a population that thinks the work ethic is a type of chocolate biscuit.
Hedge funds spent much of last year warning that France might even leapfrog Italy in the contagion queue, while betting against French government debt. So it must come as a bit of a surprise that the French 2-year bond now yields less than half that of the US, and is below the UK.
French 2 year bond yield (Source: Bloomberg)
The draft structure for Spain’s rescue of its banking system suggests a big chunk of the cost will be borne by private investors, through losses on equity and subordinated debt.
Unfortunately, this will hurt the ailing economy even more, and ultimately only save money for Spain’s eurozone partners. The bad news for banks (and good news for taxpayers and efficient resource allocation) is that it also sets a new standard for future bailouts, over-riding the local political desire to save creditors. Worse news for banks could be to come, as the logical next step is for the eurozone bail-out fund to establish rules demanding losses for senior bondholders in future bank rescues.
Charts after the break showing Spain and what looks like the mispricing of bank CDS. Read more
Will the Olympics have a positive economic impact? The question is a big, and very political one in the UK at present, as London prepares to lock down for the games. But Goldman Sachs’ big analysis, just published, suggests there really could be a return on the London games. Watch the video with Huw Pill, Goldman’s chief European economist:
Among many other points covered in the report that we didn’t reach in the video interview: Read more
Companies are talking down their earnings prospects at a record rate. For the second quarter of this year, negative pre-announcements have outnumbered positive ones by the most since the third quarter of 2001 – the quarter that included the 9/11 terrorist attacks.
That kind of shift in earnings sentiment would usually be damaging for stocks. But in this interview, Citigroup’s Tobias Levkovich comes up with an interesting argument that the worst is already over – providing the US avoids a recession.
The new blog challenge: put these in order of how awful they’ve been since the euro was created:
- Greek banks
- Irish banks
- Spanish banks
- Italian banks
- French banks
- British banks
- German banks
- American banks
It is a serious challenge, given how much everyone hates all the banks. But if forced to choose, the order might reasonably go something like the above – the periphery, in order of rescue, middling eurozone, then the Brits (many of them already nationalised, plus the Libor-struck Barclays), followed by under-capitalised Germans and finally the resurgent Americans as the best of a bad bunch.
Equity investors don’t seem to share this view, as this great chart shows. Read more
Investors need to be capable of cognitive dissonance to prosper. But the scale of doublethink in the markets has gone too far.
Consider US Treasuries and UK gilts, both near record-low yields. A large part of their investment case is that Britain and America control their central banks, and so can print money if needed – making default purely voluntary. The argument against the bonds is identical: the dollar and sterling are being debased by their central banks. Read more
Stocks have never been so correlated. The specifics of each company’s profit and loss account have become secondary to the broader factors of the market.
The figures demonstrate this beyond argument. In October last year, for example, the one-month correlation between individual S&P 500 stocks reached 90 per cent. The average since 1990 has been 30 per cent. Similarly, the correlation of different geographical indices has increased steadily. Twenty years ago, emerging markets offered great diversification from the developed world, with a correlation of almost zero. Now, that correlation is close to 80 per cent, according to MSCI indices. Read more
Was Keynes a Keynesian? I had to answer this essay question at university and managed to answer No. The issue was whether John Maynard Keynes’ 1930s ideas really entailed the interventionist policies that bore his name, and which rightly took much blame for 1970s stagflation.
Since then, an era of distinctly non-Keynesian economics by any definition has culminated in a global crash, leaving the world in what looks like what Keynes called a “liquidity trap” – where lower interest rates have little or no effect. In a week when the European Central Bank, the People’s Bank of China and the Bank of England have all eased monetary policy, the debate about Keynes’ legacy rages. It is barely a debate at all – a sterile recitation by each side of a preconceived position. Read more