One month Treasury bill rates ended the week at zilch and 3-month bills closed at one basis point. Two-year government yields were down 3 bps to 0.17%. Five-year T-note yields ended the week down 6 bps to 0.80%. Ten-year yields dropped 7 bps to 1.92%. Long bond yields fell 5 bps to 3.25%. Benchmark Fannie MBS yields dropped 7 bps to 3.11%. The spread between 10-year Treasury yields and benchmark MBS yields was unchanged at 119 bps. Agency 10-yr debt spreads declined one to 4 bps. The implied yield on December 2012 eurodollar futures increased one basis point to 0.565%. The 10-year dollar swap spread increased 2 to 22 bps. The 30-year swap spread increased 2 to negative 28 bps. Corporate bond spreads widened meaningfully. An index of investment grade bond risk jumped 10 bps to 131.5 bps. An index of junk bond risk surged 57 bps to 732 bps.
Debt issuance bounced back, at least for a week. Investment-grade issuers included Schlumberger $3.0bn, Toyota Motor Credit $2.5bn, Time Warner $2.25bn, Lockheed Martin $2.0bn, Enbridge Energy $1.14bn, HJ Heinz $700 million, Fluor $500 million, Associated Banc $430 million, Wisconsin Electric $300 million, XCEL Energy $250 million, PG&E $250 million, Public Service New Hampshire $160 million and Detroit Edison $140 million.
Junk bond funds saw inflows of $576 million (from Lipper). Junk issuance included American International Group $2.0bn, Fresenius Medical Care $400 million, and Calumet Special Products $200 million.
I saw no convertible debt issued.
International dollar bond issuers included Daimler $3.5bn, Toronto Dominion Bank $5.0bn, Rentenbank $1.5bn, Chile $1.0bn, Export-Import Bank of Korea $1.0bn, France Telecom $2.0bn, and Banco Credito $350 million.
Another week of tumult for European debt markets. Greek two-year yields ended the week up 852 bps to 53.05% (up 4,081bps y-t-d). Greek 10-year yields surged 194 bps to 19.52% (up 706bps). German bund yields sank 24 bps to a record low 1.77% (down 119bps), and U.K. 10-year gilt yields fell 18 bps this week to 2.26% (down 125bps). Italian 10-yr yields rose 13 bps to 5.39% (up 58bps) and Spain's 10-year yields increased 3 bps to 5.14% (down 30bps). Ten-year Portuguese yields jumped 85 bps to 10.87% (up 429bps). Irish yields were unchanged at 8.45% (down 61bps). The German DAX equities index sank 6.2% (down 25% y-t-d). Japanese 10-year "JGB" yields fell 6 bps to 1.00% (down 12bps). Japan's Nikkei declined 2.4% (down 14.6%). Emerging markets were weak. For the week, Brazil's Bovespa equities index declined 1.4% (down 19.5%), and Mexico's Bolsa fell 3.8% (down 12.3%). South Korea's Kospi index lost 2.9% (down 11.6%). India’s equities index increased 0.3% (down 17.8%). China’s Shanghai Exchange declined 1.2% (down 11.1%). Brazil’s benchmark dollar bond yields jumped 15 bps to 3.61%, while Mexico's benchmark bond yields were little changed at 3.40%.
Freddie Mac 30-year fixed mortgage rates were down 10 bps to 4.12% (down 23bps y-o-y). Fifteen-year fixed rates declined 6 bps to 3.33% (down 50bps y-o-y). One-year ARMs fell 5 bps to 2.84% (down 62bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 7 bps to 4.80% (down 58bps y-o-y).
Federal Reserve Credit expanded $5.0bn to $2.841 TN. Fed Credit was up $433bn y-t-d and $554bn from a year ago, or 24%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/7) dropped $9.3bn to $3.478 TN. "Custody holdings" were up $127bn y-t-d and $257bn from a year ago, or 8.0%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $1.654 TN y-o-y, or 19.3% to a record $10.226 TN. Over two years, reserves were $3.029 TN higher, for 42% growth.
M2 (narrow) "money" supply jumped $30.4bn to a record $9.570 TN. "Narrow money" has expanded at a 12.4% pace y-t-d and 10.3% over the past year. For the week, Currency added $1.7bn. Demand and Checkable Deposits rose $19.6bn, and Savings Deposits increased $19.0bn. Small Denominated Deposits declined $3.3bn. Retail Money Funds fell $6.6bn.
Total Money Fund assets increased $6.9bn last week to $2.644 TN. Money Fund assets were down $166bn y-t-d, with a decline of $195bn over the past year, or 6.9%.
Total Commercial Paper outstanding sank $32bn (8-wk decline of $171bn) to $1.066 Trillion. CP was up $94bn y-t-d, or 11.6% annualized, with a one-year rise of $7bn.
Global Credit Market Watch:
September 8 – Bloomberg (Abigail Moses): “Credit-default swaps on Greek government debt surged to a record, signaling there’s a 91% probability the nation won’t meet debt commitments, after its economy shrank more than previously reported.”
September 9 – Bloomberg (Alan Crawford): “Chancellor Angela Merkel’s government is preparing plans to shore up German banks in the event that Greece fails to meet the terms of its aid package and defaults, three coalition officials said. The emergency plan involves measures to help banks and insurers that face a possible 50% loss on their Greek bonds if the next tranche of Greece’s bailout is withheld… The successor to the German government’s bank-rescue fund introduced in 2008 might be enrolled to help recapitalize the banks… The existence of a ‘Plan B’ underscores German concerns that Greece’s failure to stick to budget-cutting targets threatens European efforts to tame the debt crisis rattling the euro… Greece is ‘on a knife’s edge,’ German Finance Minister Wolfgang Schaeuble told lawmakers at a closed-door meeting in Berlin on Sept. 7… If the government can’t meet the aid terms, ‘it’s up to Greece to figure out how to get financing without the euro zone’s help,’ he later said in a speech to parliament.”
September 9 – Bloomberg (Matthew Brockett and Jeff Black): “Juergen Stark resigned from the European Central Bank’s Executive Board after protesting the bank’s bond purchases on a conference call earlier this week, said a euro-area central bank official familiar with the meeting. During the Sept. 4 call, Stark, 63, expressed his strong opposition to the program, which was expanded last month when the ECB started buying Italian and Spanish bonds… Stark was supported by the central banks of Austria and the Netherlands, the person said… Stark’s resignation, less than two months before President Jean-Claude Trichet’s term ends, suggests policy makers are increasingly split over the best way to fight Europe’s debt crisis… ‘There is quite a severe row going on,’ said Juergen Michels, chief euro-region economist at Citigroup Inc. in London. ‘It seems that it went too far.’”
September 6 – Bloomberg (Rainer Buergin and Tony Czuczka): “German Finance Minister Wolfgang Schaeuble called on euro-area governments to fully implement curbs on debt, saying that only fiscal ‘solidity’ will help tame financial-market turmoil. Schaeuble’s comments to lawmakers in Berlin today seek to raise the pressure on euro-area states to follow Germany and clamp down on debt to tackle the core cause of the sovereign crisis that is rocking markets worldwide. Financial markets are in ‘a state of anxiety,’ requiring ‘a new mentality’ rather than short-term stimulus, he said. ‘Markets are not the problem, excesses are,’ Schaeuble said… The constitutionally mandated debt ceiling enacted by Germany and now being emulated by France and Spain is ‘of fundamental importance,’ he said. Only ‘financial-policy solidity will win the confidence of markets.’”
September 9 – Bloomberg (John Fraher): “Almost 13 years after its demise, the deutsche mark retains enough potency to haunt Jean-Claude Trichet’s final days as European Central Bank president. Trichet, 68, lost his cool yesterday with a reporter who asked whether Germany should abandon the euro and return to the mark as Europe’s debt crisis roils markets and spooks voters. ‘I would like very much to hear the congratulations for an institution which has delivered price stability in Germany for almost 13 years,’ Trichet said… in an uncharacteristically raised voice. ‘It’s not by chance we have delivered price stability,’ he said. ‘We do our job, it’s not an easy job.’ Trichet has been at the forefront of efforts to save the region’s single currency. As Greece’s fiscal crisis ricocheted through European markets, he has spent much of the last two years shuttling back and forth between Frankfurt and national capitals for private meetings and a series of marathon summits.”
September 7 – Bloomberg (Abigail Moses): “Italian government debt is more expensive to insure than Spain’s for the first time in two years on concern Premier Silvio Berlusconi’s austerity measures will fail to resolve the nation’s budget crisis. …credit-default swaps on Italy cost 456 bps, compared with 424 bps for Spain.”
September 7 – Bloomberg (Angeline Benoit): “Spain is ‘worried’ that euro-area countries such as Italy and Greece are contributing to instability on debt markets by wavering on budget-deficit plans, Development Minister Jose Blanco said. ‘We are very worried because certain countries are in a very difficult situation and aren’t meeting their targets,’ Blanco said… citing Greece and Italy for putting austerity measures into question days after announcing them.”
September 7 – Bloomberg (Flavia Rotondi and Lorenzo Totaro): “Italy may need a new budget- adjustment plan next month because a 54 billion-euro ($76bn) austerity package to be voted on today won’t convince the European Central Bank to continue buying the nation’s bonds, the chairman of the Senate Finance Committee said. ‘How long can the ECB continue to buy Italian Treasury bonds?’ Mario Baldassarri said… ‘We may need another adjustment in three, four weeks which will be the real answer to the European Commission and to markets.’”
September 9 – Bloomberg (Esteban Duarte, Joe Brennan and Gabi Thesing): “ The European Central Bank plans to dilute a proposal to wean distressed banks off its emergency funding on concern it would exacerbate the region’s debt crisis, said two euro-area officials familiar with the deliberations. Instead of imposing higher interest rates on emergency loans to penalize Greek, Irish and Portuguese banks, the ECB and national central banks would ask financial institutions to detail how they will repay the money…”
September 7 – Bloomberg (Shannon D. Harrington and Sapna Maheshwari): “Fear is overpowering greed in the $7.6 trillion U.S. corporate bond market, with investors pricing in the biggest reversal in credit quality in more than two decades as the economy falters and Europe’s debt crisis worsens. While Moody’s… raised the ratings on 12 investment-grade companies in August and lowered seven, relative yields on corporate debt jumped more than half a percentage point, the third-largest increase since at least 1989, Deutsche Bank AG strategists say. At no point in at least 22 years has the difference between bond spreads and the ratio of upgrades to downgrades been greater, according to Deutsche Bank.”
September 7 – Bloomberg (Johan Carlstrom and Kim McLaughlin): “Swedish Finance Minister Anders Borg said the government may force the country’s banks to curb their reliance on dollar funding through law changes as a global liquidity crisis shows signs of reigniting. ‘Developments during the last few days underline the importance that we actually do something about the liquidity situation,’ Borg told reporters… ‘There’s a far too big reliance on dollars in the Swedish banking system and we must eventually move away from that.’”
September 8 – Bloomberg (Paul Dobson): “JPMorgan Chase & Co. said selling Italian and Spanish bonds along with bank stocks and debt, and buying dollars and gold may provide the best protection against the ‘very unlikely’ risk of a euro-area collapse. ‘There are formidable barriers to break-up, which make it less likely, but also mean it would be more disruptive if it did occur,’ Seamus Mac Gorain, a strategist in London, wrote in an investor report… ‘The financial turmoil and economic impact would be most pronounced in the euro area, arguing for broad underweight euro-area equity and credit.’”
Global Bubble Watch:
September 7 – Bloomberg (Candice Zachariahs and Garfield Reynolds): “Federal Reserve Chairman Ben S. Bernanke risks causing a decline in longer-term lending by holding down benchmark interest rates, Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said in an opinion piece on the Financial Times website. If the Fed seeks to drive down longer-maturity yields, as some are anticipating, then the central bank may ‘destroy leverage and credit creation in the process,’ Gross wrote in the piece, which was titled ‘Helicopter Ben’ Risks Destroying Credit Creation.’ The Fed on Aug. 9 pledged to keep the benchmark rate near zero until at least mid-2013. ‘Borrowing short-term at a near risk-free rate and lending at a longer and riskier yield has been the basis of modern-day finance,’ Gross wrote. ‘The further out the Fed moves the zero bound towards a system-wide average maturity of seven to eight years the more credit destruction occurs.’”
September 5 – Financial Times (Nicole Bullock and Helen Thomas ): “Concerns are rising that turbulence in financial markets will make it more difficult to carry out billions of dollars of forthcoming debt sales to raise money for buy-outs and other deals struck this year. As merger and acquisition activity picked up earlier this year, private equity groups took advantage of buoyant credit markets, signing up a run of buy-outs soon to be marketed to investors… Bankers say there is as much as $20bn-$25bn in loan offerings and junk bond issues in the pipeline in coming months tied to M&A transactions…”
September 7 – Bloomberg (Saburo Funabiki): “U.S. banks may face a ‘heavy burden’ if the Federal Reserve embarks on a third round of bond buying because it would boost the excess reserves lenders hold at the central bank, Totan Research Co. said…Another bout of quantitative easing, or so-called QE3 probably would expand excess reserves and lead to a deterioration of banks’ debt- to- equity ratios and returns on assets, as well as an increase in deposit-insurance premiums, according to Izuru Kato, chief economist…at Totan… allied with ICAP Plc, the world’s largest inter-dealer broker.”
Currency Watch:
September 7 – Bloomberg (Simon Kennedy and Emma Charlton): “Switzerland opened a new round in a global currency war as fading economic growth forces policy makers to step up efforts to spur expansion. The Swiss National Bank’s decision yesterday to cap the franc’s rate for the first time since 1978 marked a bid to protect trade hurt by the currency that last month strengthened to records against the euro and the dollar. The franc plunged 8.1% yesterday…”
The U.S. dollar index surged 3.3% this week to 77.20 (down 2.3% y-t-d). For the week on the downside, the Swiss franc declined 10.8%, the euro 3.9%, the Danish krone 3.8%, the South African rand 3.1%, the New Zealand dollar 3.1%, the Norwegian krone 2.7%, the Swedish krona 2.3%, the Mexican peso 2.2%, the British pound 2.1%, the Singapore 2.0%, the Brazilian real 2.0%, the Australian dollar 1.6%, the South Korean won 1.3%, the Canadian dollar 1.1%, Japanese yen 1.0%, and Taiwanese dollar 0.7%.
Commodities and Food Watch:
September 6 – Bloomberg (Chanyaporn Chanjaroen): “Gold’s rally above $1,900 an ounce shows no signs of a ‘bubble’ as central banks continue to boost money supply that has helped spur bullion to a record, according to investor Marc Faber. ‘I don’t think that gold is in a bubble,’ Faber, publisher of the Gloom, Boom and Doom report, said… ‘When you buy gold, it’s an insurance against systematic failure and problems in the financial markets.’”
The CRB index declined 1.1% this week (up 0.4% y-t-d). The Goldman Sachs Commodities Index slipped 0.3% (up 4.4%). Spot Gold fell 1.4% to $1,856 (up 31%). Silver dropped 3.4% to $41.62 (up 35%). October Crude gained 79 cents to $87.24 (down 4%). October Gasoline declined 2.4% (up 13%), while October Natural Gas gained 1.1% (down 11%). December Copper fell 3.0% (down 10%). September Wheat dropped 4.0% (down 12%), and September Corn fell 3.2% (up 15%).
China Bubble Watch:
September 7 – Bloomberg: “China’s banks plan to raise as much as 160 billion yuan ($25bn) selling dim sum bonds to boost capital in a market where sales have quadrupled this year. China Citic Bank Corp. announced on Aug. 29 it plans to raise as much as 30 billion yuan selling debt in Hong Kong, and China Construction Bank Corp. said last month that most of the lender’s proposed bond issuance totaling 80 billion yuan may be sold in the city. Chinese banks raised 48.7 billion yuan in the market this year, up from 11.3 billion yuan in 2010…”
Japan Watch:
September 8 – Bloomberg (Masaki Kondo, Yumi Ikeda and Saburo Funabiki): “Foreign lenders have boosted their surplus reserves at the Bank of Japan to the most in almost six years, forgoing higher interest rate payments elsewhere to benefit from gains in the yen. Overseas banks’ excess reserves… reached 6.14 trillion yen ($79bn) in July, the highest since October 2005…”
India Watch:
September 7 – Bloomberg (Jeanette Rodrigues and Anoop Agrawal): “The cost of protecting debt issued by India’s state-run banks against default has climbed to a two-year high, spurred by concern that the lenders may have to set aside more money to cover bad loans. Five-year credit-default swaps on State Bank of India, the nation’s biggest lender, rose 102 basis points this quarter to 290 bps…”
Unbalanced Global Economy Watch:
September 6 – Bloomberg (Jeff Black): “Factory orders in Germany, Europe’s largest economy, fell more than economists forecast in July, led by a drop in export demand as the global economy cooled. Orders… dropped 2.8% from June, when they rose 1.8%...”
Central Bank Watch:
September 7 – Bloomberg (Johan Carlstrom): “Sweden’s central bank abandoned a planned interest-rate increase as global recovery prospects deteriorate, while policy makers held on to the option of raising rates in the largest Nordic economy once more this year. The benchmark repo rate was left unchanged at 2%...”
Fiscal Watch:
September 6 – Bloomberg (Angela Greiling Keane): “The U.S. Postal Service may lose $10 billion in the fiscal year ending Sept. 30, more than it had predicted, as mail volume continues to drop, Postmaster General Patrick Donahoe said… The loss will leave the… service unable to make required payments to the federal government and puts it at risk of default as it reaches its $15 billion borrowing limit, Donahoe said… ‘We are at a critical juncture,’ Donahoe, who is also the service’s chief executive officer, wrote in his testimony. Action from Congress is sorely needed by the close of this fiscal year.’”
Muni Watch:
September 7 – Bloomberg (James Kraus): “Rhode Island may cut pension benefits for 51,000 public employees and retirees to cope with a $6.8 billion shortfall in funding, the Washington Post reported…”
Crumbling Pillars:
When it comes to central banking, I’m increasingly feeling relegated to the realm of a “moderate.” I may be a harsh critic of Federal Reserve doctrine and policymaking, but the last thing I’d suggest is to “abolish the Fed.” From my perspective, it is not so much that central banking is the problem as much as it is how contemporary central bankers have governed contemporary finance. As a student of central banking and financial history, I’m a big fan of William McChesney Martin (Chairman of the Federal Reserve 1951-1970). He was the consummate principled, disciplined and conservative central banker/public servant. His Fed was unequivocally dedicated to monetary stability – and sternly independent and out of the fray of politics.
I also have the highest regard for ECB President Jean-Claude Trichet. Mr. Trichet is one of the preeminent central bankers of this era. Listening to his press conference yesterday, I was again in awe of his intellect and analytical framework, along with his command of the critical roles of central banking and monetary stability. I am at the same time saddened that the European crisis is spiraling outside of his, the ECB’s and European policymaker’s control. It’s certainly no way to end such a distinguished career (Mr. Trichet’s term ends in October).
Greek Credit Default Swaps (CDS) surged 659 bps today to a new record 3,470 bps, as the market prepares for imminent default. Greek 2-year yields jumped 852 basis points this week. Italian 10-yr yields rose 13 bps this week to 5.39%. The euro sank 1.5% today and was down 3.9% this week.
Juergen Stark resigned from the ECB’s executive board today. According to Bloomberg news, Dr. Stark’s resignation follows his recent expression of “strong opposition” to the ECB’s bond buying program. Stark was vice chairman of the German Bundesbank from 2002 to May 2006, before departing to assume responsibilities at the European Central Bank. His resignation follows Bundesbank President Jens Weidmann’s recent criticism of ECB Italian and Spanish bond purchases, and is the second prominent German central banker to back away from the ECB this year (following Axel Weber's decision not to pursue the ECB presidency).
The ECB has been a pillar of strength for a euro currency that has been a pillar of strength - in a global backdrop of acute monetary instability. These pillars seemed to start crumbling this week, much to the detriment of global financial stability. Confidence in the euro was sustained throughout the first Greek debt crisis, as contagion effects engulfed Europe’s entire periphery, and even more recently when Italian bond yields spiked higher. But the weight of an expanding debt crisis, limited policy options, increasingly divided policymakers, and unstable global markets has become just too much to bear.
When the Credit Bubble burst in Greece and in the European periphery last year, the ECB intervened to avert a financial crisis with the potential to destabilize European monetary integration. Financial and economic systems in Europe and around the world were still fragile from the 2008 crisis. The ECB clearly believed that extraordinary circumstances demanded extraordinary measures. Their policy course will be analyzed and debated for decades to come. The bottom line is that the ECB aggressively intervened in the markets, and over time accumulated huge exposures to Greek and other troubled debt. In his press conference, Mr. Trichet yesterday cited “benign neglect” - both from politicians and the markets - as the major factor that fostered the problematic accumulation of debt globally. I can’t disagree, although “activist” global central bankers clearly share major responsibility.
Perhaps history will be somewhat sympathetic, viewing that the ECB was dragged into a monetary muck created largely from the negligent mismanagement of the world’s reserve currency. All the same, with Greece on the precipice of default and Italian and Spanish yields again surging higher, it would appear the ECB’s gambit is failing. If so, there’ll be a huge price to pay.
The markets have been clamoring for a German-backed “Eurobond” that would provide troubled European governments access to inexpensive borrowings (sustaining debt issuance, maladjusted economic structures and market prices). The consensus view has been that the German’s would eventually succumb to acute market stress and agree to backstop eurozone debt. They would have no alternative from a cost vs. benefit perspective, it was thought. It has been my view that the more German officials - and citizens - saw of the unfolding global debt debacle the more determined they would be to protect the stability of their Credit system. Bloomberg news today reported that the German government has prepared a plan to protect its financial institutions in the event of a Greek default.
That Dr. Stark would resign today, in the blistering heat of crisis, is a stunning development and provides additional confirmation that the German contingent is anything but backing down. Perhaps it’s too strong to suggest that this throws ECB strategy into disarray. But the market will question the sustainability of the ECB’s support for Italy’s and Spain’s bond markets. And, no doubt, a Greek default would open a Pandora’s Box of debt problems for global financial institutions, not excluding the ECB.
The currency markets turned increasingly chaotic this week. With its commitment to link its currency to the (faltering) euro, the Swiss National Bank (SBN) with the stroke of a press release essentially destroyed the Swiss franc’s long-held safe haven status in the marketplace. The franc dropped 10.8% this week against the dollar and 7.2% against the euro, in another notable example of a policy response that only exacerbates market instability. On the back of euro and franc weakness, dollar momentum gained intensity as the week progressed. It would appear that dollar short positions (i.e. “carry trades” and such) came under heightened pressure, with euro weakness, dollar strength and general market tumult all feeding upon themselves.
Dollar strength broadened notably. This week saw many “emerging” currencies falter, including a decline in the Polish zloty of 6.0%, the Hungarian forint 5.5%, the Romanian leu 4.6%, the Czech koruna 4.0%, the Bulgarian lev 3.6%, the South African rand 3.0%, the Russian ruble 3.0%, Turkish lira 2.3%, and the Brazilian real 2.2%. To what extent “hot money” inflows had previously stoked these currencies, markets and economies remains unclear. But it would appear that global de-risking and de-leveraging dynamics broadened and intensified this week. And it becomes only more difficult to envisage a scenario where stability returns to the markets – currency, equity, fixed-income or commodities.
Whether it’s monetary or fiscal policy - at home or abroad – there seems to be confirmation everywhere that policymaking has become largely ineffectual and, increasingly, incapacitated. This is fundamental to my bearish thesis. With each passing market day it seems to take a greater leap of faith to believe that additional monetary and fiscal stimulus will ameliorate a sovereign debt crisis fomented by ultra-loose monetary and fiscal policies. Increasingly, it appears impossible for policies that fomented monetary instability to now somehow engender a return to market stability. Liquidity-challenged global markets are convulsing through a problematic period of de-risking and de-leveraging, and once such a process commences it basically has to run its course. Efforts to intervene in the marketplace, as we’ve been witnessing, are likely to beget only greater uncertainty and instability. Fed take note.
I also have the highest regard for ECB President Jean-Claude Trichet. Mr. Trichet is one of the preeminent central bankers of this era. Listening to his press conference yesterday, I was again in awe of his intellect and analytical framework, along with his command of the critical roles of central banking and monetary stability. I am at the same time saddened that the European crisis is spiraling outside of his, the ECB’s and European policymaker’s control. It’s certainly no way to end such a distinguished career (Mr. Trichet’s term ends in October).
Greek Credit Default Swaps (CDS) surged 659 bps today to a new record 3,470 bps, as the market prepares for imminent default. Greek 2-year yields jumped 852 basis points this week. Italian 10-yr yields rose 13 bps this week to 5.39%. The euro sank 1.5% today and was down 3.9% this week.
Juergen Stark resigned from the ECB’s executive board today. According to Bloomberg news, Dr. Stark’s resignation follows his recent expression of “strong opposition” to the ECB’s bond buying program. Stark was vice chairman of the German Bundesbank from 2002 to May 2006, before departing to assume responsibilities at the European Central Bank. His resignation follows Bundesbank President Jens Weidmann’s recent criticism of ECB Italian and Spanish bond purchases, and is the second prominent German central banker to back away from the ECB this year (following Axel Weber's decision not to pursue the ECB presidency).
The ECB has been a pillar of strength for a euro currency that has been a pillar of strength - in a global backdrop of acute monetary instability. These pillars seemed to start crumbling this week, much to the detriment of global financial stability. Confidence in the euro was sustained throughout the first Greek debt crisis, as contagion effects engulfed Europe’s entire periphery, and even more recently when Italian bond yields spiked higher. But the weight of an expanding debt crisis, limited policy options, increasingly divided policymakers, and unstable global markets has become just too much to bear.
When the Credit Bubble burst in Greece and in the European periphery last year, the ECB intervened to avert a financial crisis with the potential to destabilize European monetary integration. Financial and economic systems in Europe and around the world were still fragile from the 2008 crisis. The ECB clearly believed that extraordinary circumstances demanded extraordinary measures. Their policy course will be analyzed and debated for decades to come. The bottom line is that the ECB aggressively intervened in the markets, and over time accumulated huge exposures to Greek and other troubled debt. In his press conference, Mr. Trichet yesterday cited “benign neglect” - both from politicians and the markets - as the major factor that fostered the problematic accumulation of debt globally. I can’t disagree, although “activist” global central bankers clearly share major responsibility.
Perhaps history will be somewhat sympathetic, viewing that the ECB was dragged into a monetary muck created largely from the negligent mismanagement of the world’s reserve currency. All the same, with Greece on the precipice of default and Italian and Spanish yields again surging higher, it would appear the ECB’s gambit is failing. If so, there’ll be a huge price to pay.
The markets have been clamoring for a German-backed “Eurobond” that would provide troubled European governments access to inexpensive borrowings (sustaining debt issuance, maladjusted economic structures and market prices). The consensus view has been that the German’s would eventually succumb to acute market stress and agree to backstop eurozone debt. They would have no alternative from a cost vs. benefit perspective, it was thought. It has been my view that the more German officials - and citizens - saw of the unfolding global debt debacle the more determined they would be to protect the stability of their Credit system. Bloomberg news today reported that the German government has prepared a plan to protect its financial institutions in the event of a Greek default.
That Dr. Stark would resign today, in the blistering heat of crisis, is a stunning development and provides additional confirmation that the German contingent is anything but backing down. Perhaps it’s too strong to suggest that this throws ECB strategy into disarray. But the market will question the sustainability of the ECB’s support for Italy’s and Spain’s bond markets. And, no doubt, a Greek default would open a Pandora’s Box of debt problems for global financial institutions, not excluding the ECB.
The currency markets turned increasingly chaotic this week. With its commitment to link its currency to the (faltering) euro, the Swiss National Bank (SBN) with the stroke of a press release essentially destroyed the Swiss franc’s long-held safe haven status in the marketplace. The franc dropped 10.8% this week against the dollar and 7.2% against the euro, in another notable example of a policy response that only exacerbates market instability. On the back of euro and franc weakness, dollar momentum gained intensity as the week progressed. It would appear that dollar short positions (i.e. “carry trades” and such) came under heightened pressure, with euro weakness, dollar strength and general market tumult all feeding upon themselves.
Dollar strength broadened notably. This week saw many “emerging” currencies falter, including a decline in the Polish zloty of 6.0%, the Hungarian forint 5.5%, the Romanian leu 4.6%, the Czech koruna 4.0%, the Bulgarian lev 3.6%, the South African rand 3.0%, the Russian ruble 3.0%, Turkish lira 2.3%, and the Brazilian real 2.2%. To what extent “hot money” inflows had previously stoked these currencies, markets and economies remains unclear. But it would appear that global de-risking and de-leveraging dynamics broadened and intensified this week. And it becomes only more difficult to envisage a scenario where stability returns to the markets – currency, equity, fixed-income or commodities.
Whether it’s monetary or fiscal policy - at home or abroad – there seems to be confirmation everywhere that policymaking has become largely ineffectual and, increasingly, incapacitated. This is fundamental to my bearish thesis. With each passing market day it seems to take a greater leap of faith to believe that additional monetary and fiscal stimulus will ameliorate a sovereign debt crisis fomented by ultra-loose monetary and fiscal policies. Increasingly, it appears impossible for policies that fomented monetary instability to now somehow engender a return to market stability. Liquidity-challenged global markets are convulsing through a problematic period of de-risking and de-leveraging, and once such a process commences it basically has to run its course. Efforts to intervene in the marketplace, as we’ve been witnessing, are likely to beget only greater uncertainty and instability. Fed take note.
