In a weekend of very little financial news the biggest story becomes the announcement by Deutsche Bank that its plans to raise 8 BILLION EUROS ($11 BILLION) in new capital to shore up its balance sheet. (Deutsche Bank closed near its 50-week on Friday at $42.17.) I have had many calls and e-mails about the impact from this news. My response to all has been to wait to see how Deutsche Bank trades tomorrow to see if this is a buy the fact opportunity. It is no secret that DB is the most highly leveraged of all the major global banks so a capital infusion is not a surprise event as Europe undergoes ECB-mandated stress tests. The bottom line is that the DB news will have little impact upon the EURO currency or the BUND market. If Deutsche Bank had failed the upcoming stress tests that would’ve been a major news event. Eight billion euros to shore up its balance sheet is a mere ounce of prevention.
The more important news event this week will be the European elections which begin across the EU on May 22. If the radical right and/or left were to poll very strongly in France, Spain or Italy it would unnerve the Eurocrats and entrenched power elite across all the European states and probably prompt Mario Draghi to embark a real action for some type of QE program or an effort to weaken the EURO. If Draghi failed to move aggressively with monetary policy, the ECOFIN would be pushed by the political leaders to intervene to weaken the euro currency. The most significant outcomes would be in a defeat of the ruling elites by any anti-EU fringe parties.
Many pundits will claim that a small turnout will diminish the results but that just the jibber-jabber of the self-aggrandized ruling classes and their financial supporters. While the reports of a recovery in Spain, Portugal, Italy, Greece and Ireland are promoted by equity and bond pushers, the ultra-high unemployment numbers can lead the disenfranchised to use any vote a message of opposition to the status quo. Patience will be needed as the market tries to position itself ahead of any surprise. The euro/swiss cross and pound/euro cross will be good indicators of investor sentiment in Europe. Also, as we saw last week, the Italian, Spanish and Greek bond markets has some long positions liquidated as the elections near. The continued year-long rally in the peripheral debt markets has led to large profits. There’s nothing wrong with taking some gains heading into a period of potential uncertainty.
***Again, for all the pundits discussing the flattening of the yield curves, especially in the Unites States, I say NONSENSE. Below is a 30-year BLOOMBERG chart of the 2/10 yield spread and in the upper-left hand corner, readers can ascertain that the 30-year average is 112 basis points. Friday, the 2/10 closed at a recent low of 214 points, which is significantly above the average. As the chart historically shows, the curve is still steep. Yes, recent moves in the long-end of the curve have been large but there is still much support around the 175 level so I argue that the yield curve is not projecting anything dynamic at this juncture. When the time comes we hope to be ready but for now trade the market and don’t look for a major change in the fundamental picture.
Tags: 2/10 yield curve, Bund, Deutsche Bank, ECB, elections, Euro, Europe, Mario Draghi
May 18, 2014 at 9:14 pm |
Yra- I think the best way to look at the 2/10 spread is the ratio of 2 year rates to 10 year rates, I believe 10 year rates are 6 or 7 times 2 year rates, which IMO Is extremely steep.
May 19, 2014 at 1:59 am |
Yra with the ZIRP I think the focus should shift to whether the YC is steepening or flattening, rather than the absolute level. The curve can’t invert with ZIRP & to the pundits who say there can’t be a recession unless it inverts I say get your causuality correct and look to Japan.
May 19, 2014 at 3:52 am |
Thanks for your comments Yra. On your second para about the European elections, I had imagined that QE might be reserved for the risk that Angela Merkel favours an expansion of sanctions in lieu of German industry’s desire to expand its relationship with Russia, using QE to offset any anticipated weakness in the Eurozone. So if Mr Draghi has to use QE to compensate for a euro-skeptic outcome to the upcoming elections, how would he offset any trade weakness from diminished trade between Europe and the RF? Furthermore, suppose that Mrs Merkel prioritizes German industry over sanctions and EU politics, what would markets think? Would they assume Germany to have taken one step outside the Eurozone? Thanks in advance for your comments. Costas
May 19, 2014 at 4:46 am |
Shocked–using that metric makes the case even more so—but my effort is to show the perspective of where we are at on the curve–and as you aptly point out—it is steep indeed
May 19, 2014 at 1:05 pm |
Good to know in advance DB squeaked by, on the stress test. 🙂