Notes From Underground: Marco Polo returns to Italy, Bringing Chinese Riches

Well, the media was running wild in the last hour of U.S. equity trading with a rumor of the Chinese offering to purchase Italian bondsx. Every time the Euro debt crisis comes to a full boil, rumors arise about the Chinese riding to the rescue and buying beleaguered sovereign debt. In December 2009, the rumors were that the Chinese Investment Corporation [CIC] was interested in acquiring the 25 billion euros of Greek debt that was being road-showed–that was prior to the Greek Debt Crisis and the expected rate was roughly 6.5%.

The Chinese Bid never materialized and the EURO DEBT CRISIS was set in motion, sending the interest rate on PIIGS sovereign debt substantially higher. In late 2010, the Chinese were hinting at buying Portuguese debt. Again, nothing was ever confirmed and Portuguese interest rates rose dramatically. Beware of Chinese bearing GIFTS that are sent via DHL. The unverified Chinese rumors sent the EURO into rally mode and brought the U.S. equities along for the ride. The Chinese appear to enjoy titillating the markets but seem to have not stepped up as often intimated. The EUROPEAN DEBT market could certainly use some positive news but this will probably mean that like other Chinese rumors the markets will be hungry for good news again in a very short time.

Quick Hitter #1: The Spanish and Italian two-year notes gained in yield as the European debt was under stress and closed prior to the Chinese rumors. The Italian two-year rose 38 basis points to 4.45% and the Spanish two-year gained 23 basis points to a yield of 3.69%. Also, the Irish 2/10 curve flattened considerably during the last eight days as it went from 150 basis points positive to virtually flat. When stress hits, it seems that the TWO-YEAR NOTES get hit hardest, playing havoc with the yield curves.

Austerity budgets place a great deal of selling pressure on the TWOS as the curve flattens and then inverts, signaling a slowing economy. The effect of slower growth in a debt-stressed economy is further budget deterioration as revenue shortfalls beget larger deficits, thus the NEGATIVE FEEDBACK LOOP. Anybody place any credibility in the GDP numbers of the PIIGS as austerity sets in?

Quick Hitter#2: The TWIST. It used to be that the BIRD was the word but ever since Jackson Hole it has been the TWIST. Months ago I wrote about the accord of 1951 between the Treasury and the FED and brought up the TWIST as performed by the FED in the early 1960s. The belief is that the next move by the FED will be to lengthen the duration of the FED‘s balance sheet by selling shorter term Treasury paper for longer term. The FOMC and Bernanke have hinted that the TWIST was the next logical move as a QE3 program was deemed to be full of political conflict. The Wall Street crowd is thinking that a duration move by the FED will bring mortgage and corporate bond rates lower, thus help buoy the EQUITY MARKETS.

While this policy worked 50 years ago, I am concerned that today’s environment is very different: There is no Bretton Woods with a fixed currency regime and also the world has basically moved to a global financial system free of capital controls. A move by the FED may backfire as global investors shun an artificially set interest rate on sovereign debt. While some “pundits” are giddy about the TWIST, I am not as certain about the outcome. The emerging economies have already raised concern about the Quantitative Easing programs. What will be the global response to a TWIST program that places new upward pressure on many members of the G-20?

Quick Hitter#3: Peter Altmaier … remember the name. He is the the Chief Whip of Merkel’s CDU and is responsible for putting the votes together to pass the EFSF bailout program in the Bundestag. Herr Altmaier is a former Brussels Eurocrat and a German Europhile.He is the Member of Parliament responsible for delivering the support for Chancellor Merkel’s financial pledges to the EU. The success of the entire EURO and EU project may reside in his ability to force the CDU members to follow the wishes of Merkel even as the POPULAR WILL RISE AGAINST THE EURO.

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9 Responses to “Notes From Underground: Marco Polo returns to Italy, Bringing Chinese Riches”

  1. Danny Says:

    How effective will offically lower rates on mortgages be, when the current historically low mortgage rates aren’t being realized by most existing home owners? Sure seems like it won’t be. I have heard several stories at this point about seemingly good credit risk people calling banks to refi and they never seem to get called back.

  2. yra Says:

    danny–that is exactly the point about why a refi program needs to be mandated–the banks don’t want to refi and lower their eranings and ultimately wind up with a massive convexity problem

  3. arthur Says:

    Is Copper in your global macro radar screen? Copper Puts & Deflation?

  4. yra Says:

    It is not at this time Arthur–I think copper is interesting because of China.Commodities seem to serve a double purpose in China –as a raw material for use and also a stockpiled commodity to use as collateral for bank loans.if copper begins to fall it will be interesting to see how it impacts bank lending and credit in China—the higher commodities have risen the more credit has been extended–can you see a downward spiral.

  5. arthur Says:

    Quoting Julian Tiger, I would say somethinking like “If you think copper is a good short even with good economic growth and I think the world´s going to hell and Asia is going to implode, we should be short five times your amont”.

    I just don’t see copper as this hedge fund manager.

  6. yra Says:

    Arthur–no question about what you say—again I say copper is of course needed but the stockpiles are so large as China has anticipated–so futures are always efficient as a means of setting prices–eventually.Every fund manager has to stake out a position to justify 2 and 20

  7. arthur Says:

    You hit the mark.

  8. Danny Says:

    Whats the word on Greece being spun off the Euro as an idea? Larry Fink pointed out on CNBC’s conference that rolling off the Euro would cause every company in Greece (with Euro denominated debt) to default as well as the drachma would most likely collapse relative to the Euro. This definitely seems to be a semi-overlooked complication since everyone is concerned about the sovereign piece alone. What do you think?

  9. yra Says:

    Danny–not easy and depends on how it is done.If the Greeks reintroduce the Drachma it will depend how much it is depreciated .The best thing Greece has going for it is that 90% of greek debt is written under greek law—Larry Fink is not necessarily correct because it will depend on levels and the laws of Greek bankruptcy

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