Notes From Underground: Bored By Italy, But I Digress

Sorry. The current situation in the European Union has been well forecasted by NOTES FROM UNDERGROUND so until the storm clouds clear and the Italian ruling coalition begins to initiate some of its campaign proposals I treat everything in Europe as a trade and not an investment. Even the talking heads are waking up to the potential financial damage that bank balance sheets loaded with ZERO RISK-WEIGHTED sovereign bonds can cause a healthy bank’s bloated balance sheet.

On Monday, the Financial Times had a very good article detailing the European commercial banks’ exposure to Italian government bonds (“Italy Turmoil Shows Banking ‘Doom Loop’ Still A Powerful Force”). As I stressed many times at Notes From Underground, the entire European project rests on Germany’s desires. Will the German electorate acquiesce in providing the financial wherewithal to create a harmonized fiscal system and a EUROBOND to compete with the U.S. Treasury market?

The problem is that ECB President Mario Draghi has put into place the ability to create a EUROBOND. This has been the subterfuge of the massive QE program, which has been prolonged far beyond any genuine economic necessity. The political rationale may exist but the as the heightened financial repression of the German voters has done harm to the government of Chancellor Merkel.

The weekend press was filled with several articles discussing Merkel’s recent rumblings about Germany doing more to invigorate the entire European economy. But there will be pushback from the more right-wing elements of Merkel’s own party, and, of course, the Bundestag opposition group, the AfD. On Tuesday afternoon, Bundesbank President  Jens Weidmann said in an FT story, “ceding a significant portion of their sovereignty to Brussels is precisely what the Euro area members are not prepared to do. It seems to me that it’s already hard enough at times to ensure that the European Commission’s existing powers are enforced and respected.”

This is a statement from an ECB board member who is being seriously considered as the next President of the ECB. In my opinion, the Germans will not compromise, UNLESS A GERMAN IS MADE THE NEXT HEAD OF THE ECB. German voters will be averse to backstopping the ECB without a greater sense of control.

During Tuesday’s trading session the EURO CURRENCY staged a strong rally upon the release of a rumor reported by Bloomberg that the ECB is said to see June 14 as a live meeting to debate the QE exit. From the story: “President Mario Draghi’s Governing Council is likely to treat the June 14 gathering in Latvia as a live opportunity to debate winding down bond-buying ,said the officials,who asked not to be named because such matters are CONFIDENTIAL,” (emphasis mine).

This Bloomberg story is irresponsible as it won’t name the sources so anybody can move a market enough to cause volatility and make a few rubles. I am skeptical of this although I don’t doubt it will be debated for a minute. The question will be what will Mario Draghi reveals at the press conference.

The Italian situation has already created a black eye for Draghi as he has been accused of intruding on Italian politics by failing to fill the quota of Italian bond purchases when Italian yields were spiking. It’s doubtful that the ECB will want to further kick the hornet’s nest of political populism. To add further doubt the veracity of the BLOOMBERG story, I offer up the opinion that for the past year Reuters has seemed to be the source of ECB-quality leaks.Bloomberg rushed to get out ahead and drove the get away car for some financial miscreants.

***Another must-read in the FT: “Fed’s Dilemma Grows More Acute After EM and Europe Turmoil,” (Joe Rennison and Robin Wigglesworth). This is an argument that has validity and raises the issue about the FED having a triple mandate because of the position of the DOLLAR as the world’s reserve currency. The current Governor of the Reserve Bank of India, Urjit Patel, said, “Given the rapid rise in the size of the U.S. deficit, the Fed, must respond by slowing plans to shrink its balance sheet. If it does not Treasuries will absorb such a large share of dollar liquidity that a crisis in the rest of the dollar bond markets is inevitable.”

This is a critical outlook for its cites the critical issue of a three-pronged attack on liquidity, which may be the cause of the dramatic flattening of the U.S. yield curve. If the FED wishes to reduce its balance sheet it ought to refrain from raising the FED FUNDS rate until it has some sense of the impact from the draining of reserves as Treasuries roll off. Peter Boockvar and Jim Bianco have raised this issue during the previous months  but the concern of the RBI’s Patel should give a heightened sense of concern at the Powell Fed. Let the digressions continue.


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9 Responses to “Notes From Underground: Bored By Italy, But I Digress”

  1. Stefan Jovanovich Says:

    The European Commission budget for 2018 is 160B Euros. That is funded by commitments fron the EU member nations. For the EU to have a Euro “Treasury” market equivalent to the United States, it must have a revenue structure that is not a mimicry of the American colonies’ Articles of Confederation. Until then, sovereign debt in the EU is the equivalent of the State bond market in the U.S. if all the state bonds were cross-collateraluzed and the Fed accepted them as reserve assets and there was no Federal Treasury debt. The U.S. government collects its own direct taxes to fund its borrowings; its budget is 3.8T dollars – more than 20 times the EC’s indirect collections.

  2. yraharris Says:

    Stefan–excellent post and good points.But I disagree as Draghi has followed the script of George Soros by backdooring a synthetic bond by accumulating so much sovereign debt on the ECB’s balance sheet.To not minimize Draghi’s 2012 speech about whatever it takes to save the EURO.Draghi makes up the rules as he goes along which is why he is the most dangerous man ,especially if the German Constitutional Court follows its previous rulings about fiscal policy and thus bond s being under the authority of Parliament.There is very great concern in that this has all been well crafted at the G30 meetings which combines government officials with private sector investors—wow what a combination to circumvent the General Will

  3. Chicken Says:

    Not sure how much longer they can Merkle through.

    Side note: How’s the opposite of populism expressed?

  4. Trader 1 Says:


    If your thesis plays out that the Germans will demand a German be next ECB President:

    What is your best guess how ECB policy would be carried out? Would bond buying be reduced? How would the German handle the Draghi created Euro Bond ECB Balance sheet? Would the German run ECB policy more as a “German” Euro Currency ??

  5. Mike Temple Says:

    Seems like the best course of action is to buy S&P. Market is absorbing all,this “known” information and sees that Trump and Powell have everything under control. EUR/Italy is Europe’s problem, not the US……#MAGA by imposing tariffs and berating NFL players.

  6. asherz Says:

    EU Peripheral state debt although very serious, is small potatoes compared to another cloud that is much more ominous. DB described
    Deutche is a primary writer of derivatives and is the counter party to many trillions. It is on the road to insolvency. The solution will be for a government takeover of the bank. So Frau Merkel will now have this huge albatross added to its already ATM status in Europe. CDS paper will be much looked for but unreliable. Other banks will follow this road to Hades.
    And NASDAQ makes an all time high.
    The market is listening to Irving Fisher and is deaf to Roger

  7. asherz Says:

    Roger Babson

  8. Chicken Says:

    Gold miner ETF (GDX/GDXJ) BB’s are tightening, something this way comes?

  9. Mike Temple Says:

    Gold stocks likely to plummet as BB’s resolve themselves.
    “Risk on”is the mantra as Italy doesn’t matter and peace is coming to Korean Peninsula.

    Besides, millennials and doomsters prefer the crypto store of value.

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