Sunday, 8 May 2011

Vae Victis - the acceleration in the European turmoil and markets review

April has made a turn for the worse. While we have witnessed a flight to safety with further tightening of German 10 year government debt, for peripheral countries, things have turned sour.

2 Year Greek debt ended April at an incredible 26% yield with 5 year CDS reaching 1350 bps, equating to a cumulated probability of default of around 68%. On the 7th of April, Portugal threw in the towel and asked for help, meanwhile ECB's concerns on inflation was marked by a raised to 1.25% of its key rate.

Greece Sovereign CDS reaching stratospheric levels in April:

Greece is facing a wall of maturity between 2012 and 2015, bond redemptions represent 112 billion Euros. No matter what Georges Papaconstantinou says, a restructuring cannot be avoided. It is already priced in the market. Greece has around 330 billion euros in outstanding bonds.
Greece debt distribution:

Greek bonds deterioration accelerated in April:

Real Estate Market in Greece is falling:

Non-performing loans in Greece surging:

A debt restructuring for Greece, three options:
-Reduction in the coupon
-Extension of the maturity
-Both extension of maturity and extension of the coupon

European Union finance officials, had an unannounced meeting May 6 in Luxembourg. They are trying the help to ease the debt burden. It would be better to deal with the restructuring now than later. The pain inflicted will be larger down the line. They have to stop kicking the can down the road and bite the bullet, time is running out fast.
Luxembourg Prime Minister Jean-Claude Juncker is still trying to avoid it: “We were excluding the restructuring option which is discussed heavily in certain quarters of the financial markets,”. The consequences of the ongoing turmoil affected the Euro which dropped like a stone from 1.49 to 1.43 in a couple of days:

There is a wall of refinancing for Greece but the elephant in the room for Greece in particular, and for some other countries in general, is the issue of unfunded liabilities (Ponzi scheme?):

A clearer picture on unfunded liabilities for Greece, a gigantic problem:

Portugal Sovereign CDS has reached the level of Ireland, the widening has been significant since February:

Following issues relating to the Peripherals in trouble, namely Spain, Portugal and Ireland, Spain, Italy and Belgium widen on Friday according to CMA:

But concerns on Spanish banks in the CDS market have come down since February:

Spain is the last line of defense. The revised ESM in March, in conjunction with the EFSF is enough to ensure proper liquidity issues for Greece, Portugal and Ireland until 2013, but cannot be viewed as resolving the outstanding solvency issues.
Spanish GDP grew 0.2 percent in the 1st quarter, matching 4th Quarter 2010. GDP expanded 0.7 percent from a year earlier according to the Bank of Spain on the 6th of May.
IMF forecast a GDP expansion of 0.8% in 2011, while the central bank forecast the economy will expand 1.5%.
Consumer spending is still weak with record unemployment. Spain has one of the highest private-debt burdens in the euro region. 97 percent of mortgages have variable rates, which mean that further rate hikes from the ECB could potentially have a serious impact on an already fragile economy.

As a reminder (from my post Europe - The end of the Halcyon days, this is the German banks exposure to peripheral debt:

And another reminder, Countries cross border exposure:

Consequences of European turmoil, U.S. two-year note yields dropped on Friday to the lowest level since March. Flight to quality or is it?

In the US:
U.S. added 244,000 jobs according to the NFP published on Friday but unemployment was up, reaching 9% from 8.8 percent in March, the first increase since November.
US GDP growth slowed to 1.8 per cent in the first quarter of 2011: Slowdown, headwinds and headaches...
ISM’s index of non-manufacturing companies fell heavily to 52.8 in April, the lowest since August 2010, from 57.3 in March.
Retail sales rose by 0.6 percent in April, up from 0.4 percent.
Overall we have very mixed data.

Risk of a double dip?
We have a double dip in housing in the US.
Housing is still very weak and still falling in the US. U.S. home prices back down to their 2009 lows according to the S&P Case-Shiller Index for February.
Sales of new single-family houses in March 2011 were at a seasonally adjusted annual rate of 300,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development. This is 11.1 percent (+/-21.7%)* above the revised February rate of 270,000, but is 21.9 percent (+/- 10.3%) below the March 2010 estimate of 384,000. Still very weak.
We have an acceleration in distressed sales in Q1 in the US, as well as falling prices. Economic 101: Higher percentage of distress sales = downward pressure on house prices.

For more on the US weekly summary, the always excellent CalculatedRisk blog:

Summary for Week ending May 6th

Positive news worth tracking for the US:
"New Households Form at Fastest Rate Since ’07 in Resurgent U.S."according to this Bloomberg article.

This is important to track as it will generate positive contribution to GDP.

Good thing about recession (or is it?):
Divorce rates are falling. From the same Bloomberg article:
"The number of divorces dropped to 6.8 per 1,000 people in 2009 from 7.4 in 2006 prior to the recession, according to the National Center for Health Statistics in Hyattsville, Maryland."

Fed and BOE kept rates at the same level in April. The Fed has kept its target rate for overnight lending between banks at zero to 0.25 percent since December 2008.

Commodities update: Pop goes the bubble in conjunction with Glencore's IPO? How ironic.

Silver in a tailspin after an unsound meteoric rise:

Tip for silver or possibly the trade of the year?
How to make 6.3 millions USD profit since April 11 on Silver? Start with a 1 million USD bet:
Would The Silver Medalist Please Stand Up?
"Market watchers want the anonymous April silver bear in listed options to take a bow. The unknown investor's mid-April $1M bet that iShares Silver Trust (SLV) would hit $25 or lower before mid-July is worth more than $7M after this week's plunge. Not just the drop in price, but huge jump in price volatility, has goosed has enriched this trader's options position. "The investor didn't get this trade right. He or she got it spectacularly right."
source Dow Jones.

The big positive for GDP: The drop in Oil prices
2008 Redux?

The WTI contract lost 15.4 per cent from Monday's peak near 115 USD, a level last seen in early September 2008.

Higher resource prices act as a tax and sap consumer disposable income.
Oil prices receding are indeed good news. Commodity prices have been driven to excess by speculators, the correction so far is not due to faltering demand in emerging markets.

What happened to curb the ongoing speculation:
CME futures exchange has increased margin requirements sharply, rapidly and several times. Traders had the choice of putting up more cash for their trades or cash in, taking their profits.

This is a very important lesson to be learned: This shows what can be done by the authorities to pop bubbles.
We all know the common know adage: "Don't fight the Fed". For commodities, here is a new one, don't fight the authorities.

For Silver the bubble has clearly pupped, oil has well, for the moment.

"The fall in the price of oil and commodities is good to take for all reasons, certainly for inflation, not only immediately but with the danger of second-round (effects) in the medium run," ECB President Jean-Claude Trichet declared.

"It is also good to take in terms of consolidating the recovery because any increase in the price of oil and commodities has an inflationary impact and a depressive impact (on growth)," he added.

A welcome respite in the surge in commodities.
We shall see in the coming months if it is just a big pull back like we had in 2008. Let's see how long this one lasts!

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