European Chaos

„Zeus gave Europa a necklace made by Hephaestus and three additional gifts: Talos, Laelaps and a javelin that never missed.“


Laelaps was a dog that never failed to catch what it was hunting, while Talos was a giant made of bronze who circled Crete to protect the island from attack. Somehow both the dog and the javelin seem to have been lost.

The volume of financial news Europe generates in a single day is almost overwhelming –  for a newspaper editor these days it must be sheer agony to decide which one of all these items should actually decorate the front page.

As we write this, investors are back relying on that well-worn strategy known as 'hope'. European stock markets are bouncing and we read that 'crude oil rises to near $87 amid hopes that President Barack Obama's major policy speech later this week will provide a catalyst for stronger U.S. economic growth'.

You have to be utterly desperate, not to mention slightly loopy if you actually buy 'risk assets' on 'hopes' that Mr 'Shovel-Ready' will bail you out. We do believe that the great bulk of market participants – the herd if you will – is quite irrational, but they are probably not that far gone. The better explanation is that we are seeing a bounce to relieve oversold conditions. As an aside, there was recently a bullish divergence between the European markets and the SPX, so there actually is now an additional technical reason to look for a bounce.

Below is a list of the recent news items out of Europe worth considering with links to the articles discussing them. We have excerpted a few pertinent snips from the most important ones:

The WSJ reports, 'Bank Deposits at ECB Jump'.

“Euro-zone banks' overnight deposits at the European Central Bank rose Monday to the highest level in more than a year, indicating rising fears that the currency bloc's sovereign-debt crisis could deepen.

Banks deposited €166.85 billion ($235.23 billion) at the ECB, the central bank said Tuesday, up from the previous 2011 peak of €151.1 billion recorded Friday. The total was the highest since deposits hit €172.09 billion on Aug. 9 2010.”


"The fact that almost all this excess liquidity is going back to the ECB is a sign of stress," said Patrick Jacq, an interest-rate strategist at BNP Paribas in Paris.

"This is driven by the situation in Europe, where sovereign-debt concerns have an impact on interbank liquidity, given the large exposure of European banks to sovereign risk." A level above €100 billon signals market uncertainty, indicating that banks prefer to park their money with the ECB instead of lending it to one another.”


(emphasis added)

The fact that there is stress in the euro area's interbank lending market  is not new, but it is noteworthy that the level of stress is still increasing.



3 month LIBOR soars –  although the absolute level is still low, it compares unfavorably with the zero interest rates on Federal Funds and the fact that t-bills quite often sell at a premium instead of a discount these days (i.e., they occasionally sport negative interest rates) – click for higher resolution.



Three month, one year and five year euro basis swaps – another indicator of bank funding stress in the euro area – click for higher resolution.



The speaker (CEO) of Germany's Deutsche Bank, Josef Ackerman, reportedly feels himself reminded of 2008:

“The chief executive officer of Deutsche Bank AG (DBK), Josef Ackermann, said yesterday market conditions remind him of late 2008, and urged lawmakers to act to avoid a repeat of the financial crisis, which spawned the worst global recession since the Great Depression. Investors drove yields higher on the bonds of Greece, Portugal, Spain and Italy yesterday on doubts Europe’s leaders will be able to stop the sovereign debt contagion.

“Investors are not only asking themselves whether those responsible can summon the necessary willpower to overcome this crisis, but increasingly also whether enough time remains and whether they have the needed resources available,” Ackermann, 63, said at a conference in Frankfurt. “As long as uncertainty holds whether the agreements can be quickly and fully implemented, the nervousness on the market will remain.”

Not surprisingly, even Deutsche Bank has lately seen its stock succumb to heavy selling. We would remind readers that Germany's and Europe's largest bank is also one of its most highly leveraged financial institutions.


Shares of Deutsche Bank plunge by about 20% in just three trading days – click for higher resolution.



Other European bank stocks didn't fare any better – even the ones outside of the euro area. In spite of the fact that what remains of their share prices are mere cents, Italian and Greek bank stocks keep falling to new lows. The short selling ban instituted in France has meanwhile had no discernible positive effect on the stocks concerned. Below are the charts of several of these stocks. Note that these charts do not yet include Wednesday's bounce – by the close of  today's trading all of them will probably be slightly higher.



Societe Generale hits yet another new low in Tuesday's trading – click for higher resolution.




BNP Paribas keeps falling to new lows as well – click for higher resolution.



The shares of Unicredito, Italy's largest bank, fall to a mere 80 cents – click for higher resolution.



The shares of Intesa SanPaolo, Italy's second largest bank – click for higher resolution.



National Bank of Greece lands at a new low – remember the 'hopium bounce'? All of it and more has been given back in just five trading days – click for higher resolution.



Shares of the UK's RBS surrender the gains of two weeks in just two days – click for higher resolution.



As we have pointed out many times, we believe that at its heart, this is not only a crisis of the European welfare states and their unpayable debt.  At its heart it is a crisis of the fractionally reserved banking system.  The manner in which fiat money 'works', whereby the debt issued by sovereigns is used as the 'reserves' of the banking system, is deeply flawed. In the euro area this has merely become obvious more quickly than elsewhere as the supranational central bank stands in the way of member nations  'inflating the debt away'.

The entire monetary system rests ultimately on a mixture of coercion and faith. Legal tender laws prescribe that fiat money must be used in discharging public and private debts, while the idea that the debt issued by sovereigns represents a 'reserve' for the fiat money issued rests on the notion that these states will forcibly take more of their citizens wealth in the future. Given the size of the liabilities, both currently extant and so-called 'unfunded' liabilities, it appears people think that there is a sheer endless reservoir of wealth that can be plundered. Or rather, 'used to believe'. Confidence in this system certainly appears to be crumbling, although no-one in the establishment as of yet questions the system as such, at least not publicly.


Regarding the euro area banks, our indicator of the CDS on several major European banks continues to rise sharply as well. This is an unweighted index of CDS on BBVA, Deutsche Bank, Socgen, BNP, Intesa, Monte dei Paaschi, and Unicredito.



Our CDS index of seven major European banks makes a new high. This is now way above the highs seen in the 2008/9 crisis – click for higher resolution.



A long term chart of our euro-area bank CDS indicator shows how much more worried the market is about euro area banks today relative to the 2008 crisis – click for higher resolution.



A long term chart of the EuroStoxx bank index – almost back at the 2008/9 crisis low – click for higher resolution.



The news out of Germany meanwhile are 'mixed'. The German constitutional court has once again sided with the government and upheld the first bailout of Greece and the founding of the EFSF, which may be one of the triggers for today's bounce in European shares. At the same time, it has 'thrown a bone' to the complainants, just as we suspected it would. As the WSJ reports:

“Germany's Federal Constitutional Court Wednesday ruled that the euro-zone's 2010 bailout for Greece and subsequent aid granted through the currency bloc's rescue fund is legal, eliminating a major hurdle to the sovereign debt crisis response that's been closely watched by financial markets.

The constitutional court in Karlsruhe also ruled that Germany's Parliament should have more say in major future euro-zone bailouts, but these would only need approval from the parliament's budget committee. This requirement is less strict than some proposals circulated by key government lawmakers that call for the plenary's approval, a move that could stall the pace of future bailout efforts by giving more lawmakers influence to sway the decision process.

The ruling marks a victory for German Chancellor Angela Merkel, who has been stung by a series of party losses in local elections this year and faces fierce resistance in Germany for her handling of the euro-zone crisis.”


(emphasis added)

As Dr. Schachtschneider once remarked in the context of the influence the German government has on the court's decisions,  the 'judges do have a telephone'.  The fact that 'approval from parliament's budget committee' will be required is the bone thrown to the complainants. There's not a lot of meat on that bone to be sure.

As the WSJ report states further:

“The court ruling could now make it easier for Merkel to win parliamentary approval at the Sept. 29 vote for changes to make the euro-zone bailout fund, the European Financial Stability Facility, larger and more flexible, as agreed to in Brussels in July.

The euro briefly rose against the dollar after the ruling, but reversed gains as traders digested the court's warning that the ruling wouldn't serve as a blank check for future bailouts.

"Today's ruling should bring some relief to financial markets as a total chaos scenario has been avoided but it shouldn't lead to euphoria," writes ING Economist Carsten Brzeski. "A bigger say for German parliament in future bailouts could easily find copycats in other euro-zone countries, undermining the clout of the beefed-up EFSF and later the ESM," the euro-zone's permanent bailout mechanism.

Under Wednesday's ruling, the constitutional court decided the government hadn't violated German property rights by agreeing to the initial bailout of Greece in 2010 as well as the subsequent rescues of Ireland and Portugal through the EFSF.


(emphasis added)

In other words, although this ruling is a victory fort the pro-bailout camp, it is at the same time a bit of a poisoned chalice.

In economic news, German factory orders declined far more than expected, as exports were hit hard. Meanwhile, there is still a revolt against the bailout policy brewing in Mrs. Merkel's own political backyard, as 25 MP's from the ruling government coalition refused to back a draft of the new EFSF/bailout law. Mrs. Merkel concurrently assured lawmakers that 'Greece won't get any more funds unless it meets the conditions of the bailout', which is tantamount to saying 'Greece will default', as it is impossible for it to meet said conditions.

German Chancellor Angela Merkel told members of her Christian Democrats that Greece will not receive aid payments due this month unless it meets conditions of the rescue, two party officials said.

The remarks, made at a meeting of ruling party lawmakers in Berlin late yesterday, were repeated by Finance Minister Wolfgang Schaeuble and reiterate existing policy, one of the officials said, speaking on condition of anonymity because the talks were in private.

“It was very clear that we expect Greece to meet its obligations, that there can’t be more aid without adequate behavior by Greece,” Peter Altmaier, the chief whip for Merkel’s Christian Democratic Union, told reporters after the talks. “But it was also very clear that we stand by our commitments within the euro stabilization and that we’re ready to maintain and defend the euro as our common currency.”

Merkel’s coalition is trying to appease voter anger at government moves to prevent a euro-region breakup by putting more taxpayers’ money on the line. The lower house will hold a first reading on Sept. 8 of a bill raising Germany’s share of loan guarantees to 211 billion euros ($297 billion) from 123 billion euros — four days after Merkel’s CDU suffered its worst-ever result in an election in her home state.

“The basis for all these programs is that we provide aid under certain conditions,” Klaus-Peter Flosbach, CDU financial- policy spokesman in parliament, said in an interview. “There can be a situation in which we are no longer willing to help when the conditions aren’t met.”


(emphasis added)

The markets took this as a cue to go 'no bid' on Greek government debt, with the one year government note yield soaring to 88% on Tuesday. In other words, the market keeps telling us that a Greek default is as close to an absolute certainty as these things get.



Greece's one year government note yield soars to 88% – click for higher resolution.



The biggest news on Tuesday was however the decision of the Swiss National Bank (SNB) to 'peg' the Swiss franc to the euro at a rate of 1,20 (franc per euro). To this end, the SNB promises to 'buy foreign currency in unlimited quantities'.

“The SNB is “aiming for a substantial and sustained weakening of the franc,” the Zurich-based central bank said in an e-mailed statement. “With immediate effect, it will no longer tolerate a euro-franc exchange rate below the minimum rate of 1.20 francs” and “is prepared to buy foreign currency in unlimited quantities.”


While the computerized trading algorithms that rule markets these days took the subsequent plunge in the CHF as a reason to sell gold, we would point out that it is actually not bearish for gold when yet another perceived 'safe haven' disappears in the ocean of inflationism that informs today's central bank policies. What exactly is not clear about the phrase 'unlimited amounts'? The SNB was allegedly worried about the 'deflationary threat' posed by the strong CHF, but in the meantime it has actually injected so much money into the system that it is literally drowning in freshly printed francs, with short term interest rates on CHF denominated bills well in negative territory. In any case, we have warned several weeks ago already that the huge bullish consensus on the CHF indicated that the currency would soon top out and move lower. It likely would have done so with or without intervention – the intervention merely accelerated the process.



The Swiss Franc plunges after the SNB announces its new policy of pegging it to the euro – click for higher resolution.



In euro area stock markets, we would note that our idea that the DAX was immersed in  a 'bearish running correction' has turned out to be correct:



The DAX index falls from a bearish 'running correction'. However, this has created a positive divergence with the S&P 500 – click for higher resolution.



Other European markets also fell to new lows, and are therefore also putting in a divergence with the S&P 500 index that may help to support a short term bounce:



Italy's MIB hits a new low on Tuesday – click for higher resolution.



The MIB is now very close to the 2009 low. This level will very likely serve as strong support from whence a multi-week or multi-month bounce could begin. Note however that if this support level fails to hold, all hell will break loose – click for higher resolution.



Greece's Athens General Index also hits a new low – it is now down over 85% from its 2007 high – click for higher resolution.



The SPX diverges from the European markets by putting in a higher low. Whether this divergence will be meaningful remains to be seen, but it is certainly something worth paying attention to – click for higher resolution.



Gold looks actually a bit short term toppy after putting in a reversal candle on extremely high trading volume on Tuesday. However, we expect it to eventually go even higher following a period of consolidation. In the meantime, gold stocks may actually offer better value for investors – click for higher resolution.



Meanwhile, the fall in the Swiss franc provides some relief to underwater borrowers of CHF denominated mortgages in Eastern Europe and elsewhere,  as well as to the banks that are the biggest lenders in this giant carry trade gone wrong.

Another news item worth relating is that the eurocracy and the IMF continue to  quarrel over the capital needs of euro area banks. The eurocrats have now 'convinced' the IMF that it needs to lower its estimates of how much capital these de facto insolvent banks require. According to the NYT:

“Euro zone governments have no plans to inject any further capital into banks over and above the money earmarked for the financial sector in the emergency loan programmes to Greece, Ireland and Portugal, sources said. Euro zone officials discussed the issue of banking sector recapitalisation on Monday and Tuesday as part of the preparations for the informal meeting of European Union finance ministers in Poland on September 16.

The issue has returned to the table after the IMF called for additional capital to boost the European banking sector, estimating the extra need at 200 billion euros (175 billion pounds) in a draft version of an unpublished report leaked to the press.

"We have discussed this with the IMF in detail and the IMF has agreed that this initial figure will be revised downwards and the revision will be quite substantial," a euro zone official participating in the talks said.

"There is a need for additional capital in the European banking system but the magnitude of the required recapitalisation is nowhere near the initial number of the IMF," the official said.

Euro zone officials estimate banks have in total already raised some 50 billion euros in additional capital in the run up to the European bank stress tests in July and now had between six and nine months to further increase it where necessary.

"In all likelihood it will be private capital that will be raised. For public money, we have no plans of a large scale or any banking recapitalisation programme over and above the contingency reserve for the financial sector in the three programmes that we are currently running," the official said.”


(emphasis added)

Extend and pretend lives on….after all, officially there is no crisis in sovereign debt. That is just an invention of the 'locusts' that inhabit the financial markets. So we actually don't need to mark anything to market, right? The chutzpa of the eurocrats continues to amaze.

Speaking of 'locusts' (this is Silvio Berlusconi's term of endearment for speculators and investors), in Italy there is now a strike on in protest against the 'austerity measures'  most of which the government has lately been busy  backing off from anyway. However, growing pressure from the financial markets is once again forcing the government's hand. Passage of the austerity plan is now tied to a confidence vote in parliament, which could conceivably still upset the proceedings.

“Italy's centre-right government promised on Tuesday to hike value-added tax as it bowed to market pressure for more action on its swollen debt and ignored mass street protests against its austerity measures.

With Italian bonds coming under renewed attack, Prime Minister Silvio Berlusconi met ministers as the Senate began a debate opening the way for approval of the 45.5 billion euro package on Wednesday.

The air of crisis was heightened by anti-austerity rallies across the country after Italy's powerful CGIL union called a one-day strike to protest the programme, which includes a measure it says will make it easier to sack workers.

After days of fruitless wrangling over funding gaps in the plan, the government agreed to raise the 20 percent VAT bracket to 21 percent in a move that employers federation Confindustria estimated could raise 3.7 billion euros a year. It also set a special 3 percent levy on incomes of over 500,000 euros, although to add to the already high level of confusion over the package, Defence Minister Ignazio La Russa said later the threshold would be lowered to 300,000 euros.

Ministers will also approve the introduction into the constitution of a "golden rule" on balanced budgets and transfer provincial government functions to the regions in a move to simplify local administrations.  Other changes would delay retirement for women employed in the private sector from 2014.

A confidence vote will be called which should see the package passed in Senate on Wednesday, offering some reassurance ahead of Thursday's meeting of the European Central Bank governing council which has been pushing Rome for action.  Approval in the lower house would then be needed for the package to be passed.”


(emphasis added)

Not surprisingly, Italian government  bond yields have once again been soaring lately, just as the ECB's bond buying program diminished somewhat. An especially tough pasting was delivered to these bonds in Monday's trading.


Euro Area Credit Market Charts

Below you find our usual collection of charts of CDS spreads, bond yields, euro basis swaps and a few others. Prices in basis points, color-coded where applicable. As can be seen, as of Tuesday, the crisis was back in full force across the almost the entire spectrum of financial instruments. CDS on France's, Italy's and Spain's  sovereign debt hit new all time highs, along with several others. Euro basis swaps widened deeper into negative territory, and the bond yields of Greece, Italy and Spain have once again risen sharply.



5 year CDS on Portugal, Italy, Greece and Spain – new highs for Italy and Spain. Italy's CDS spreads at 450 basis points – they are now where Portugal's where back when it was first  noted that 'Portugal is not Ireland' (hat tip to Seeking Alpha's news editor for that one). Respectively, they are now where Ireland's CDS were when people noted that 'Ireland is not Greece'. Oh well – click for higher resolution.



5 year CDS on Ireland, France, Belgium and Japan – France and Belgium at new highs of 183 and 285 basis points respectively – click for higher resolution.



5 year CDS on Bulgaria, Croatia, Hungary and Austria – new highs all around – click for higher resolution.



5 year CDS on Latvia, Lithuania, Slovenia and Slovakia  – no new highs yet, but these are all bullish charts … – click for higher resolution.



5 year CDS on Romania, Poland, Slovakia and Estonia – the fall in the CHF-euro rate hasn't really helped yet here – click for higher resolution.



5 year CDS on Saudi Arabia, Bahrain, Morocco and Turkey – all rising again – click for higher resolution.



A log chart of our euro area bank CDS index shows that it is just about to break above a long term resistance line – click for higher resolution.



The three month euro basis swap – deep in 'crisis territory' – click for higher resolution.



Inflation adjusted yields hit a long term support line in Europe – click for higher resolution.



10 year government bond yields of Ireland, Greece, Portugal and Spain – all in gear to the upside again. Greek yields hit a new post euro adoption high – click for higher resolution.



10 year government bond yields of Italy and Austria, UK gilts and the Greek 2 year note. Safe haven yields at new lows, while Italy's and Greece's yields soar – click for higher resolution.



5 year CDS on the 'Big Four' Australian banks  – the recent correction is evidently over – click for higher resolution.



The gold-silver ratio keeps rising – this is a negative for 'risk assets' and credit spreads – click for higher resolution.



The dollar index has suddenly come to life following the SNB's intervention and on account of the euro weakening considerably in recent days – click for higher resolution.



The euro weakens as the markets expect the ECB to at least hint at coming rate cuts on Thursday – click for higher resolution.



The US 10 year treasury note hits a new post WW2 low, well below the 2% barrier. This market is now very overbought (the price of the t-note moves inversely to its yield). A pause/ correction is probably imminent – click for higher resolution.




Charts by: Bloomberg, Bigcharts,


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7 Responses to “Close The The Edge, Down by The River…”

  • foxhend:

    I noticed that you mentioned that the fall in the Swiss Frac gave some relief to the Swiss Banks that are heavy investors in Eastern European Mortgage loans denominasted in Swiss Francs. How real a problem is this? Does it make the Swiss banks as risky as the Euro Zone Banks with their soverign holdings? Can one feel relatively safe in holding money in the smaller/medium Swiss Banks? I know that Credit Swiss and UBS might be too risky.

  • Calrin, silver is an industrial metal. Last time the ratio went near 100. Generally if you get beyond about 55, it is evidence a credit crunch is present and likely to get worse. You can get $20,000 worth of gold in your pocket pretty easily. Even at these inflated prices, try to get 500 OZ of silver in your pocket. Not so precious.

  • Floyd:

    Thanks for the excellent article!

    The SNB announcement is quite amazing. Are there nuts? As commented on another blog, they would be better off using their freshly printed CHF to buy commodities or so.
    Aren’t commodities better than the depreciating fiat currency of other nations?

    Gold’s 5% decline, presumably a response to the SNB and German hi-court, is notable as well.
    If anything, it was ripe for consolidation (and thse events provided good excuses).

    PS: I’m skeptic about any particular short term movement and explanation.

    • I agree in principle with that skepticism, but it is a fact that there are many systematic macro traders out there these days and their intermarket trades have a clear recency bias.
      Of course, once they act, they tend to trip stops, and as you say, an ‘excuse’ to take profits was anyway all it took for some people to take a little off the table.
      I only wanted to mention the systematic traders because I have observed their growing influence closely over the past few years, and I know a little bit about how some of them go about ‘tweaking’ their algos.

  • calrin:

    “The gold-silver ratio keeps rising – this is a negative for ‘risk assets’ and credit spreads – click for higher resolution.”

    Can you explain why this is?

    • It is as Mannfm11 said, the industrial demand component is fairly important for silver. This is why usually when economic confidence declines, the gold-silver ratio will rise. One could also use other ratios, but per experience gold-silver is a very close fit with the stock market and credit spreads.
      I would however also note in this context that the monetary demand component for silver has apparently increased in importance in the course of this year.

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