“There ain’t no room for the hopeless sinners,
who’s hurt all mankind just to save his own,
have pity on those whose chances grow thinner
’cause there’s no hiding place from the kingdom’s throne.”
The sentiment is aptly described in this song but also in Niall Ferguson’s book, “War of the World.” In the book, Ferguson explains that European bond markets were initially unfazed at the start of World War I. They traded at a steady valuation, even as the troop trains were heading for the front.
Today there was more finger-pointing at the Germans for their continued stance on fiscal austerity and the enormous current account surplus sitting in Berlin’s bank accounts. There was increased concern about Italian banks and the threat of zombie institutions plagued by non-performing loans. But the ECB’s QE policy maintains the market’s lust for 10-year Italian notes yielding 1.47%. What’s even more disconcerting for sovereign bond buyers is in July 2012 when Italian 10-year notes were suffering under the threat of the end of the EU, the yield was above 7% and the Italian debt-to-GDP ratio was 123.3%. Today, at considerably lower yields, which makes debt servicing costs minimis, the debt-to-GDP ratio has grown to 132.7%. Growing debt-to-GDP ratios while servicing costs drop is a problem plaguing France, Spain, Portugal and most certainly Greece.
The debt situation in Europe worsens by the day even as the ECB manipulates borrowing costs lower. This issue will be further complicated in June when the ECB begins purchasing investment grade corporate bonds. Many global corporations are rushing to raise cash in Europe through bond offerings aware that the ECB will be pushing rates ever lower. Let’s raise cash in the EU and do stock buybacks in the U.S. However, if the EURO GOES HIGHER THE COST OF BUYING BACK THE DEBT WILL INCREASE. It seems that the globalization of capital in the extreme will present Mario Draghi with some unintended consequences. The ECB is taking failing assets onto its balance sheet to compensate for the risk involved. (This is a situation that is also plaguing insurance companies and pension funds.) The failure of markets to correctly price risk, as warned by Jeremy Stein, is providing fuel for the debt train. Patience for all who buy a cheap ticket.
***Tomorrow the Bank of England will announce its interest rate decision. There will be no change as Mark Carney will hold off until the Brexit issue is resolved. The uncertainty of the market’s reaction will keep volatility high as this qualifies as a low probability, high impact event. The FOOTSIE and GILT markets remain very calm in the face of the fear mongering from the “stay” crowd.
***Also on the U.K.: Queen Elizabeth was caught on camera calling the Chinese diplomats rude on a recent visit to Britain. It seems that Chinese policy makers complained about many things when President Xi Jinping visited. I will remind her highness that wearing jewelry paid for with the profits from creating millions of Chinese opium addicts may also be deemed as rude. Everyone has their own historical timeline. Now, we can get on with dealing with the world’s genuine problems? I have a TRAIN TO CATCH.