Armageddon Averted? Not So Fast.
Mario Draghi was eager yesterday to point out that the measures taken by the ECB have 'avoided an imminent credit crunch' in the euro area and pointed to the decline in various government bond yields as a measure of success.
Italy sold € 12 billion of bills yesterday, at the upper end of the target range and at a far better yield than on occasion of the last sale, seemingly underscoring Draghi's assertions.
„European Central Bank President Mario Draghi said the bank has averted a serious credit shortage and there are signs the economy is stabilizing, signaling policy makers may resist cutting interest rates further for now.
“According to some recent survey indicators, there are tentative signs of stabilization of economic activity at low levels,” Draghi said at a press conference in Frankfurt today after the ECB kept its benchmark interest rate at 1 percent following two straight reductions. While the debt crisis poses “substantial downside risks” to the economic outlook and the ECB remains “ready to act,” Draghi gave no indication that another rate cut is imminent.
With the euro area on the brink of a second recession in three years, some signs of economic resilience have given the ECB room to assess the impact of its stimulus measures to date, which include lending a record amount of cash to banks. Draghi said those loans prevented a “serious” credit contraction. He also noted that borrowing costs for governments across the 17- nation region have dropped.“
Well, not so fast. It seems everybody has forgotten about Standard & Poors. The rating agency reminded people today that it is still around – and that a raft of downgrades of euro area sovereigns is imminent.
„The Standard & Poor's ratings agency could announce the downgrades in the credit ratings of a number of European governments as early as Friday, said two government sources familiar with the matter. One person familiar with the matter said an S&P notice is being circulated among euro-zone governments and that an announcement "could be imminent."
S&P declined to comment on the possibility of an imminent announcement on euro-zone credit ratings. In December S&P placed 15 of the 17 euro-zone countries on watch for possible downgrade, citing new systemic stresses that are pressuring the euro zone's credit standing as a whole.
Talk that S&P is on the brink of downgrading several European countries pushed the euro to a fresh session low against the dollar in Friday trading in New York. The common currency dropped as low as $1.2688, down from $1.2814 late Thursday, according to EBS via CQG. It was most recently trading at $1.2698.
The biggest question for financial markets is whether France will lose its triple-A rating after showing signs of fiscal slippage during its economic slowdown over the past year.
Any downgrade of France's rating will, indirectly, raise the cost of borrowing for the European Financial Stability Facility, whose own rating depends largely on the credit quality of the countries that back it. The EFSF, which has also been placed on negative credit watch by the S&P, would then have to pass on those higher borrowing costs to countries such as Ireland and Portugal, making it even harder for them to reduce their budget deficits as planned. „
Sounds like 'festivus interruptus'. Of course, why anyone would be surprised by this is mysterious. It hasn't been a secret that these downgrades are coming. Nor has it been a secret that once France loses its AAA rating – which seems highly likely – the EFSF will turn into a lead balloon.
Moreover, Austrian media reported a rumor that not only France, but also Austria is highly likely to lose its AAA rating tonight.
Is The Party In 'Risk Assets' Over?
The rumor about downgrades being imminent has not surprisingly cut the recent party in stocks and euro area sovereign bonds short. As it were, the stock market was ripe for a downturn anyway – all it needed was a trigger. Recently complacency has scaled fresh heights. The AAII bear percentage has fallen to a six year low for instance. A blow-out in the spread between the OEX put/call ratio and the equity put/call ratio indicates that the 'smart money' has been buying puts while the public has piled into calls. The mutual fund cash-to-assets ratio is right back at an all time low.
The spread between the OEX and equity put/call ratios is at one of its most bearish extremes in all of history (via sentimentrader.com) – click chart for better resolution.
Yesterday's sinking spell in euro area sovereign yields (ex Greece of course, the one year note yield of which exceeded 400% for the first time) has reversed today as well, although not to the extent one might have expected. However, once the downgrades actually roll in, things are apt to become more dicey again.
Stock markets are a different matter: for some time the SPX has defied the downward trend in US treasury note yields. This divergence has been a big warning sign – but there are of course questions as to the extent to which 'Operation Twist' has made this signal less reliable than it normally is. We would however warn against such rationalizations – in the markets it is generally better to take things as they are.
Yesterday the financial media made a big deal about the Yale 'crash confidence index', which shows that market participants are now more worried about a crash than at any time since 2009. This is of course a contrary indicator, or so it is held. Again, we would warn about such generalizations.
The Yale crash confidence index – people are scared of a crash when it is low, but does this necessarily mean the market will rise? No, it doesn't – click chart for better resolution.
Consider the sentiment indicators in their totality: everything points to an astonishing degree of complacency, and only the 'crash fear' indicator says people are scared of a potential crash. We think this may well make a crash more rather than less likely, as any decline that happens on account of the current complacency is bound to intensify these fears and could lead to a wave of indiscriminate selling. Moreover, whenever the financial media make a lot of noise over a specific indicator and its alleged implications, it is usually a sign that the indicator no longer works.
Credit Market Charts
Below is our customary collection of charts updating the usual suspects: CDS spreads, bond yields, euro basis swaps and several other charts. Charts and price scales are color coded (readers should keep the different scales in mind when assessing 4-in-1 charts). Prices are as of Thursday's close.
During and after the ECB press conference, euro area CDS and bond yields generally softened further. However, as noted above, the threat of more downgrades seems apt to derail this recent happier state of affairs.
As noted before, the recent pullbacks have not yet altered the overall bullish look of CDS and bond yield charts (which by implication, is medium to long term bearish for euro area sovereign bonds and 'risk assets').
Only the recovery in euro basis swaps looks very solid at this point in time – yesterday the three month basis swaps recovered by another 10 basis points.
5 year CDS on Portugal, Italy, Greece and Spain – click chart for better resolution.
5 year CDS on France, Belgium, Ireland and Japan – click chart for better resolution.
5 year CDS on Bulgaria, Croatia, Hungary and Austria – click chart for better resolution.
5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – click chart for better resolution.
5 year CDS on Romania, Poland, Lithuania and Estonia – click chart for better resolution.
5 year CDS on Germany, the US and the Markit SovX index of CDS on 19 Western European sovereigns – click chart for better resolution.
Three month, one year, three year and five year euro basis swaps – another solid move – click chart for better resolution.
Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – also looking better – click chart for better resolution.
The three month euro basis swap, long term. This gives a good idea of the extent of the recent rebound in a big picture context – click chart for better resolution.
5 year CDS on two big Austrian banks, Raiffeisen and Erstebank – the latter is still subject to bad vibes from Hungary – click chart for better resolution.
10 year government bond yields of Italy, Greece, Portugal and Spain – Draghi's press conference was greeted with a big decline in bond yields across the peripheral board – click chart for better resolution.
The 9-year Irish government bond yield, the 2 year Greek note yield, and the yield on UK gilts and the Austrian 10 year government bond – we could entitle this chart 'Austria ignores Hungary' – click chart for better resolution.
5 year CDS on the debt of Australia's 'Big Four' banks – still firmly on the road to nowhere as a big triangle gets built – click chart for better resolution.
Charts by: Bloomberg
It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
2 Responses to “ECB in Premature Victory Lap, Threat of Downgrades Renewed – Is the Party Over?”
Most read in the last 20 days:
- Gold Price Skyrockets in India after Currency Ban – Part III
When Money Dies In part-I of the dispatch we talked about what happened during the first two days after Indian Prime Minister, Narendra Modi banned Rs 500 and Rs 1000 banknotes, comprising of 88% of the monetary value of cash in circulation. In part-II, we talked about the scenes, chaos, desperation, and massive loss of productive capacity that this ban had led to over the next few days. Indian prime minister Narendra Modi – another finger-wagger, as can be seen in this...
- Gold Price Skyrockets in India after Currency Ban – Part II
Chaos in the Wake of the Ban Here is a link to Part 1, about what happened in the first two days after India's government made Rs 500 (~$7.50) and Rs 1,000 (~$15) banknotes illegal. They can now only be converted to Rs 100 (~$1.50) or lower denomination notes, at bank branches or post offices. Banks were closed the first day after the decision. What follows is the crux of what has happened over the subsequent four days. India's prime minister Nahendra Modi, author of the...
- Gold Price Skyrockets in India after Currency Ban – Part IV
A Market Gripped by Fear The Indian Prime Minister announced on 8th November 2016 that Rs 500 and Rs 1,000 banknotes would no longer be legal tender. Linked are Part-I, Part-II and Part-III updates on the rapidly encroaching police state. The economic and social mess that Modi has created is unprecedented. It will go down in history as an epitome of naivety and arrogance due to Modi’s self-centered desire to increase tax-collection at any cost. Indian jewelry...
- A Note on Gold and India – What is Driving the Gold Price?
Hidden Motives It is well-known that India's government wants to coerce its population into “modernizing” its financial behavior and abandoning its traditions. The recent ban on large-denomination banknotes was not only meant to fight corruption. Obviously, this very bad Indian has way too much cash. Just look at him, he looks suspicious! Photo via thenewsminute.com In fact, as our friend Jayant Bhandari has pointed out, fresh avenues for corruption ...
- Will Trump Do What Reagan Couldn’t?
Depravity and Degeneration BALTIMORE – Finally, it’s over. We were both delighted and appalled by the news. A smile spread over our face... and our steps lightened... as we looked ahead to four years without Hillary Clinton’s know-it-all mug in the news. Praise be! This mug will be largely missing from the airwaves and the intertubes in coming years. And your caption scribbler PT won't have to look for a fall-out shelter! We thank the Lord and the American public for...
- India's Currency Debacle – An Interview with Jayant Bhandari
A Major Crisis Last week Jayant Bhandari related the story of the overnight ban of certain banknotes in India under cover of “stamping out corruption” (see Gold Price Skyrockets In India after Currency Ban Part 1 and Part 2 for the details). Banned 500 rupee banknotes The problem is inter alia that the sudden ban of these banknotes has hit the Indian economy quite hard, given that 97% of all transactions in the country are cash-based. Not only that, it has...
- Inflation Expectations Rise Sharply
Mini-Panic Over Inflation After Trump's Election Victory We have witnessed truly astonishing short term market conniptions following the Donald Trump's election victory. In this post we want to focus on one aspect that seems to be exercising people quite a bit at present, namely the recent surge in inflation expectations reflected in the markets. Will we have to get those WIN buttons out again? A 1970s “whip inflation now” button. The only thing that was actually needed...
- Will the Swamp Swallow Trump?
Permanently Skewed TRUMP HOTEL, New York – Trump’s rambling army – professionals, amateurs, camp followers, and profiteers – is marching south, down the I-95 corridor. There, on the banks of the Potomac, it will fight its next big battle. Lieutenants in Trump's army: Bannon, Flynn & Sessions Photo credit: Drew Angerer / AFP Here at the Diary, we do not like to get involved in politics. But this is a special time in the history of our planet – a...
- There Are Two Types of Credit — One of Them Leads to Booms and Busts
Stumped by the Bust In the slump of a cycle, businesses that were thriving begin to experience difficulties or go under. They do so not because of firm-specific entrepreneurial errors but rather in tandem with whole sectors of the economy. People who were wealthy yesterday have become poor today. Factories that were busy yesterday are shut down today, and workers are out of jobs. What has caused the bust? The modern-day economic orthodoxy continues to be unable to provide...
- All Aboard! Trump’s Express Train to the Future
Free Money! BALTIMORE – Last week, the Dow punched up above 19,000 – a new all-time record. And on Monday, the Dow, the S&P 500, the Nasdaq, and the small-cap Russell 2000 each hit new all-time highs. The last time that happened was on the last day of December 1999. Ironically, two events that were almost universally expected to trigger large stock market declines were followed by quite rapid and strong gains. Would the market have fallen if Hillary Clinton had won...
- Gold Bull Market Remains Intact – Long Term Fundamentals Outweigh Short Term Market Gyrations
A Strong First Half of the Year, Followed by Another Retreat In early 2016 gold had a big bull run. The precious metal rose close to 25% this year, pushed higher in a summer rally that peaked on July 10th. Gold experienced a bumpy ride over the remainder of the summer though, as investors became increasingly concerned about a potential rate hike by the Federal Reserve. Uncertainty returned to gold market and has intensified further since then. Initially, gold rallied sharply...
- Too Early for “Inflation Bets”?
The Trump Trade After 35 years of waiting... so many false signals... so often deceived... so often disappointed... bond bears gathered on rooftops as though awaiting the Second Coming. Many times, investors have said to themselves, “This is it! This is the end of the Great Bull Market in Bonds!” The long bond's long cycle – red rectangles indicate when the post 1980 bull market was held to be “over” or “over for sure” or “100% over”, etc. We have...