Monday, October 24, 2011

An underwhelming summit unveils the dead euro-parrot

If this is a Monday, then it's time to read the news from the euro summit of the week from the weekend. The news appears to be highly underwhelming. Bruno Waterfield of the Telegraph reports that the level of disunity has increased and panic is setting in. First came the bombshell [emphasis added]:
[A] new bombshell hit as a joint report by the EU and the International Monetary Fund (IMF) warned that, without a default, the Greek debt crisis alone could swallow the eurozone's entire €440 billion bailout fund - leaving nothing to spare to help the affected banks of Italy, Spain or France.
What's more, the IMF is now adding a condition of a 50% Greek debt haircut to its commitment to help the eurozone:
The IMF would no longer be willing to pick up a third of the total bill for rescuing Greece, a contribution worth €73 billion, unless European banks were prepared to write off 50 per cent of Greek debt.
Personal relationships are breaking down:
Interpersonal relations between eurozone leaders have hit an all-time low, reflecting sharp disagreements between Germany and France over using the ECB to bailout the euro and presenting an additional obstacle to finding a "grand solution" to Europe's debt crisis.
Nicolas Sarkozy's "two faced" personality has been cited as a major factor in his dysfunctional relationship with Angela Merkel. 
The rift between Berlin and Paris is growing:
A row between the pair [Merkel and Sarkozy] in Frankfurt on Wednesday overshadowed leaving-do celebrations to mark the end of Jean-Claude Trichet's nine years as the head of the ECB.

"Their shouting could be heard down the corridor in the concert hall where an orchestra was about to play the EU's anthem, Ode to Joy," said an incredulous EU official.
While a certain amount of animosity can be expected when the horse trading happens, but this scene of euro disintegration is beyond the pale.

Merkel: "Trust us"
So what was accomplished over the weekend?

Reuters reports that Angela Merkel, who has become quite accomplished at playing the press, stated that "she expected a breakthrough in efforts to come up with a comprehensive response to the euro zone debt crisis on Wednesday". Will the markets focus on the assurances of a "breakthrough" and a "comprehensive response"? (Is a "comprehensive response" a backtrack from last week's announcement of an "ambitious solution"?)

In what few details there came out, a bigger role for the ECB has been ruled out, which is a disappointment as I wrote last week that for any plan to succeed, the ECB has to agree to a bigger role which involves quantitative easing. Further to my last post on this topic, the Economist agreed and wrote that "the single currency’s future will hinge on whether Mr Draghi is brave enough to be radical."

In addition, Italy has been pressed by her EU partners to get her fiscal house in order. Just watch the body language in the video of the Merkozy press conference when they are asked about Italy. This news is not exactly helpful to the nervous bond market as the 10-year Italy-Bund yield spread is already blowing out:

It appears that European banks will be forced to raise their capital within a very short time. In this interview with Gillian Tett of the FT, Larry Fink of Blackrock expressed his concerns that forcing banks to conform to such capital ratios in such a short time creates incentives for banks to shrink balance sheets, which would plunge Europe into a deeper recession when it can least afford to do so.

This parrot is dead
Last week, equities were in rally mode as they focused on the positive news in Europe and as I write this, ES futures are flashing green. The fact of the matter is, this euro-parrot is dead. We can either accept it now, or wait until Wednesday to find out the grisly news.

The sooner market participants move from denial to acceptance, the better.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.


FGH said...

Wow! This is some pretty strong stuff. I recall that in late 2008 as everything was disintigrating, you offered up in this blog a list of stocks that would "rise like a Pheonix" after the dust settled...and you were dead on right! You haven't really offered specific stock picks lately, but maybe this is a good moment to do so for when this newest dust storm settles?

Michele said...

It's not dead, it's just pining for the fjords.

Unknown said...

OK I admit I am stupid 51 year old American. What is a Euro Parrot?

Cam Hui, CFA said...

FGH - I think it's a little early to look at a Phoenix strategy, but that time will come.

MCB - For the euro-parrot, click on the link at the bottom of the post entitled "denial" and the one entitled "acceptance".