Bill Gross was the darling of “access media” for promoting his favorite trade (what he called the short of a lifetime), the German bund. It captured the headlines on financial blogs but it is the wrong trade. If an investor wished to trade the “short of a lifetime,” the more appropriate tool would be the FRENCH OAT (the name for the French 10-year bond). It seems that Gross’s logic is based on the fact that the German BUND can only drop to -20 basis points because the ECB has determined that it will not purchase sovereign debt yielding less than its official reserve rate so over the time the BUND has a ceiling on its potential value. Gross is making the case that the ECB has so badly distorted the sovereign debt markets through its QE program that valuations are badly misaligned, BUT THE FRENCH OAT IS MUCH MORE OVERVALUED.
Yes, German growth is far outpacing the rest of the eurozone, thus the ECB’s interest rate is wrong for the German economy. This is going to be a political problem for Brussels as the German citizens are going to become disenchanted with receiving ultra-low interest rates on their savings in a high growth economy–the paradigm of financial repression. The French growth story is tepid at best and while French sovereign debt yields 27 basis points more than German bunds the slight differential is not worth the risk of France’s structural problems.
The following chart, courtesy of Bloomberg, will show the vast difference between the German and French budgets. Germany has a slight SURPLUS while FRANCE has a sizable deficit. The problem is further compounded for shorting the BUND rather than the OAT because the German debt is considered to be the highest form of collateral for operating in the European REPO MARKET and thus will continue to be in demand by the financial system. Also, because Germany maintains a massive trade surplus and France a significant deficit, the minimal spread between German and French yields renders the French 10-YEAR OAT the true short of a lifetime.
Now, economic logic would dictate that the BUND should depreciate far more because of its GROWTH story but because the ECB has broken the European sovereign debt markets through its intervention all assigned values are meaningless. However, I will add a very important warning to those model builders of econometric risk. IF THE EUROZONE AND EURO WERE TO DISSOLVE, GERMAN YIELDS WOULD RISE IN RESPONSE TO THE REAL GERMAN ECONOMY. WITHOUT THE GOOD CREDIT OF THE BUNDESBANK, THE FRENCH AND OTHERS THEN WOULD BE SADDLED WITH THE THREAT OF SOLVENCY RISK AND RATES ACROSS THE EUROPEAN PERIPHERALS WOULD SOAR, INCLUDING FRANCE WITH ITS LARGE TWIN DEFICITS. For proof, look back to the financial markets in July 2012, before Draghi’s “whatever it takes” speech.
The bottom line is Bill Gross is right. Debt levels are mispriced because of the ECB but it is the French oat that is the most egregiously overvalued. The problem for traders is that the ECB‘s 60 billion euro bond buying program has the ability to distort every bond market on any given day. If it runs out of bunds to buy, the ECB resorts to purchasing all the others. I hate to be cynical but the ECB sets the price of everything and the value of nothing. If the German people acquiesce to transferring large sums of money to support all the debt plagued European states then the German bund will be the greatest short of a lifetime, but the Bundestag providing the vast amount of funds will not be in our lifetimes.
***Quick hitters from the weekend:
1. ECB President Mario Draghi commented from the IMF meetings. He said, “It’s pointless to go short the euro.” It seems that Draghi believes that the eurozone is getting its house in order as it experiences, “… growth, fairness, fiscal sustainability and financial stability.” It amazes that Mario Draghi is now confident of a quick European rebound. The DAX and CAC have sustained sizable rallies as foreign investors have found European stocks valuable in a negative interest rate environment. Also, the 20 percent drop in the EURO has caused investors to believe that European corporations will sustain a competitive edge due to the weakened state of the EURO. Maybe being SHORT the EURO hasn’t been pointless.
2. IMF Director Christine Lagarde was reported to have said, “… the Fund will not countenance a moratorium on debt repayments.” In an Ambrose Evans-Pritchard article in the London Telegraph–“Greek Crisis Deepens As IMF Shoots Down Hopes For Payment Relief”–Lagrade is quoted: “We have never had an advanced economy asking for payment delays. It is clearly not a course of action that would be fit or recommended. This would mean additional contributions by the international community and some of the countries are in a direr situation than those seeking the delays.” Lagarde also said “… she will inform Mr. Varoufakis about ‘precedents and history’ of the IMF’s process, alluding to the semi-sacred status that the FUND expects to enjoy as the world’s lender-of last-resort.”
This is all nonsense and shows that Director Lagarde has no respect for the democratic process, for the Greek citizens have voted to say they care nothing about precedents and history. The world is dynamic except when it comes to the IMF coffers. In answering the question about Lagarde’s concern for additional contributions, it is time that the IMF utilizes it GOLD HOARD by monetizing it. Again, take the GOLD and offer GOLD-BACKED IMF BONDS to global investors, so it’s not violating IMF covenants and liquefy a static reserve. It boggles my mind that a KEYNESIAN-based institution such as the IMF cannot find a creative use for the notorious BARBAROUS RELIC.
The issuing of GOLD-backed debt would provide the funds that the IMF claims it needs to deal with a growing global financial system. I am sure that the Chinese authorities would be very happy to swap U.S. dollar reserves for IMF GOLD. IMF GOLD-BACKED BONDS COULD OFFER A 2% YIELD AND A GUARANTEE OF TWENTY GOLD IF THE DEBT GOES INTO ARREARS. NOW THAT IS A BOND NOT TO BE SHORT.