Europe was/is/will be the catalyst for the markets, from equities and commodities to, of course, currencies. Whether the problems are violent strikes in Athens or insolvent banks in France and Spain, the issues that PLAGUE EUROPE ARE EXISTENTIAL IN NATURE. Can the problems of sovereign default and the deflationary impact rippling from a massive deleveraging be contained by a massive douse of LTRO or QE3 in the U.S.? For now the markets are CONTENT to allow the flood of liquidity be the potion for increased portfolio risk.
By all objective analysis, the Greek DEFAULT has been decided for how else can one explain the GREEK 2-YEAR INTEREST RATES AT 125%? For traders and investors, the operating question is WHEN? My opinion is that it will be post-FRENCH ELECTIONS so as to prevent a FRENCH BANKING CRISIS from driving a stake through the chances of Nicholas Sarkozy. Until there is some type of real default, the waxing and waning of market ebullience will be dependent on the ability of the ECB and EFSF to keep a bid to the DEBT of the other GIIPS. The Greek citizens have been made the poster child of the “SHRINK TO GROW” crowd and up to this point the only outcome has been an ADVERSE FEEDBACK LOOP, which has paralyzed the Greek economy.
The significance of the February 29 LTRO announcement cannot be overstated. It seems that ECB President Mario Draghi will utilize the Greek crisis to make the LTRO as robust as possible. Some analysts believe that a ONE TRILLION EURO PLAN IS WHAT IS NEEDED. There is probably some truth in that as the EQUITY RALLIES HAVE INDICATED. The other issue will be what the ECB does to question of collateral. If the requirements on COLLATERAL are lessened then the impact will be as great as a 500 BILLION LTRO, so the issue at hand is complex.
There is much to digest during the next two weeks but the recent rallies in EQUITIES are going to be tested by the outcome of the ECB‘s decision. The ECB‘s failure to be aggressive enough will place the ball back in the FED‘s court.
***Today, France and Belgium removed the restrictions on shorting bank stocks as the regulators felt enough calm has come to the market. If investors and hedgers can short BANKS it may well relieve some of the pressure on the PERIPHERAL DEBT MARKETS, which has served as a PROXY for hedging bank risk. This may greatly affect the ITALIAN BOND as it has the only futures contract and became the receptacle of all the angst of the sovereign and bank debt holders. The trading action in BTP futures is to be monitored to see if the new regulations force the shorts to cover as participants move to short the bank stocks. Again, it is far too early to know but it may signal a dynamic change.
***A quick comment on Bernanke’s Friday Atlanta speech to the home builders. The speech was a revelation of the FED chairman’s fears and it served to provide the rationale for the FED‘s very soft January FOMC statement. Mr. Bernanke remains very concerned about the impact and wealth effect from the loss of $7 TRILLION in HOME EQUITY. If you add in the fact that the U.S. EQUITY MARKETS (S&Ps) have not yet regained the high levels that coincided with the housing downturn, the hit to household balance sheets is ENORMOUS so the economy remains sluggish at best. BERNANKE is worried that the 25-35 year-old group is not buying homes even as prices drastically decline as new household formation is very low.
It seems from my anecdotal study–four children in the group–that the next generation is burdened with so much COLLEGE DEBT that living at home is the best way to repay outstanding loans before taking on new obligations. The FED CHAIRMAN is very concerned about the housing weakness especially in an ultra-low interest environment. THE PERFECT RATIONALE FOR THE RECENT EXTENSION OF ZERO INTEREST RATES TO 2014. Oh well, BEN, there will continue to be Europe.