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
You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add 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:
- Modi’s Great Leap Forward
India’s Currency Ban – Part VIII India’s Prime Minister, Narendra Modi, announced on 8th November 2016 that Rs 500 (~$7.50) and Rs 1,000 (~$15) banknotes would no longer be legal tender. Linked are Part-I, Part-II, Part-III, Part-IV, Part-V, Part-VI and Part-VII, which provide updates on the demonetization saga and how Modi is acting as a catalyst to hasten the rapid degradation of India and what remains of its institutions. India’s Pride and Joy Indians are...
- Global Recession and Other Visions for 2017
Conjuring Up Visions Today’s a day for considering new hopes, new dreams, and new hallucinations. The New Year is here, after all. Now is the time to turn over a new leaf and start afresh. Naturally, 2017 will be the year you get exactly what’s coming to you. Both good and bad. But what else will happen? Image of a recently discarded vision... Image by Michael Del Mundo Here we begin by closing our eyes and slowing our breath. We let our mind...
- US Financial Markets – Alarm Bells are Ringing
A Shift in Expectations When discussing the outlook for so-called “risk assets”, i.e., mainly stocks and corporate bonds (particularly low-grade bonds) and their counterparts on the “safe haven” end of the spectrum (such as gold and government bonds with strong ratings), one has to consider different time frames and the indicators applicable to these time frames. Since Donald Trump's election victory, there have been sizable moves in stocks, gold and treasury bonds, as the election...
- The Great El Monte Public Pension Swindle
Nowhere City California There are places in Southern California where, although the sun always shines, they haven’t seen a ray of light for over 50-years. There’s a no man’s land of urban blight along Interstate 10, from East Los Angeles through the San Gabriel Valley, where cities you’ve never heard of and would never go to, are jumbled together like shipping containers on Terminal Island. El Monte, California, is one of those places. Advice dispensed on Interstate...
- A Trade Deal Trump Cannot Improve
Worst in Class BALTIMORE – People can believe whatever they want. But sooner or later, real life intervenes. We just like to see the looks on their faces when it does. By that measure, 2017 may be our best year ever. Rarely have so many people believed so many impossible things. Alice laughed. "There's no use trying," she said: "one can't believe impossible things." "I daresay you haven't had much practice," said the Queen. "When I was your age, I always did it for...
- Pope Francis Now International Monetary Guru
Neo-Marxist Pope Francis Argues for Global Central Bank As the new year dawns, it seems the current occupant of St. Peter’s Chair will take on a new function which is outside the purview of the office that the Divine Founder of his institution had clearly mandated. Neo-Papist transmogrification. We highly recommend the economic thought of one of Francis' storied predecessors, John Paul II, which we have written about on previous occasions. In “A Tale of Two Popes” and...
- Where’s the Outrage?
Blind to Crony Socialism Whenever a failed CEO is fired with a cushy payoff, the outrage is swift and voluminous. The liberal press usually misrepresents this as a hypocritical “jobs for the boys” program within the capitalist class. In reality, the payoffs are almost always contractual obligations, often for deferred compensation, that the companies vigorously try to avoid. Believe me. I’ve been on both sides of this kind of dispute (except, of course, for the “failed”...
- Trump’s Trade Catastrophe?
“Trade Cheaters” It is worse than “voodoo economics,” says former Treasury Secretary Larry Summers. It is the “economic equivalent of creationism.” Wait a minute - Larry Summers is wrong about almost everything. Could he be right about this? Larry Summers, the man who is usually wrong about almost everything. As we have always argued, the economy is much safer when he sleeps, so his tendency to fall asleep on all sorts of occasions should definitely be welcomed....
- Money Creation and the Boom-Bust Cycle
A Difference of Opinions In his various writings, Murray Rothbard argued that in a free market economy that operates on a gold standard, the creation of credit that is not fully backed up by gold (fractional-reserve banking) sets in motion the menace of the boom-bust cycle. In his The Case for 100 Percent Gold Dollar Rothbard wrote: I therefore advocate as the soundest monetary system and the only one fully compatible with the free market and with the absence of force or fraud...
- Trump’s Plan to Close the Trade Deficit with China
Rags to Riches Jack Ma is an amiable fellow. Back in 1994, while visiting the United States he decided to give that newfangled internet thing a whirl. At a moment of peak inspiration, he executed his first search engine request by typing in the word beer. Jack Ma, founder and CEO of Alibaba, China's largest e-commerce firm. Once he was a school teacher, but it turned out that he had enormous entrepreneurial talent and that the world of wheelers, dealers, movers and...
- Side Notes, January 14 - Red Flags Over Goldman Sachs
Red Flags Over Goldman Sachs Just to prove that I am an even-handed insulter, here is a rant about my former employer, Goldman Sachs. The scandal at 1MDB, the Malaysian sovereign wealth fund from which it appears that billions were stolen by politicians all the way up to the Prime Minister, continues to unfold. The main players in the 1MDB scandal. Irony alert: apparently money siphoned off from 1MDB was used to inter alia finance Martin Scorcese's movie “The Wolf of...
- Silver’s Got Fundamentals - Precious Metals Supply-Demand Report
Supply-Demand Fundamentals Improve Noticeably Last week was another short week, due to the New Year holiday. We look forward to getting back to our regularly scheduled market action. Photo via thedailycoin.org The prices of both metals moved up again this week. Something very noticeable is occurring in the supply and demand fundamentals. We will give an update on that, but first, here’s the graph of the metals’ prices. Prices of gold and silver...