The Greek Collateral Problem

A while back we discussed a specific problem inherent in the EU/IMF bailout of Greece, Portugal and Ireland that has very likely exacerbated the crisis in their bond markets. The bailouts were originally thought to be a ‘stop gap’ measure until these governments were able to return to the markets for financing their debt. The problem is that the IMF and EFSF bailout loans have priority relative to the existing debt outstanding. Since the holders of the government bonds issued prior to the bailouts are no longer the most senior creditors, their expected recoveries in the event of a default will be commensurately lower. On the one hand, the bailout efforts are shifting more and more debt onto the tax payer financed entities as existing debt matures, on the other hand, the greater the amounts lent out by these entities, the lower the expected recoveries for the remaining outstanding pre-bailout bonds will be if a default occurs anyway. Consequently the decision to provide the bailout funds has almost certainly put additional pressure on the prices of bonds issued by the governments concerned.


This problem has been brought to the fore again late last week when the IMF noted its opposition to the idea that Greece should provide collateral in exchange for receiving bailout funds. If Greece were to accede to Finland’s demand for collateral, or agree to any other, wider collateral provision involving several or all euro area nations, the IMF’s seniority with respect to post default recoveries would obviously no longer be assured. In so many words, the IMF will probably not be able to continue lending money to Greece if a collateral facility is put in place.

As Bloomberg reports:


“ The International Monetary Fund opposes European plans to force Greece to put up collateral in its second rescue, said four people with direct knowledge of the matter.

The use of collateral, a concession to win Finland’s backing for 109 billion euros ($155 billion) of loans pledged by euro leaders in July, would deny the IMF priority creditor status and violate Greek bondholders’ rights, said the people, who declined to be named because the talks are in progress.

IMF objections threaten to snag Europe’s crisis-management effort after aid of 256 billion euros for Greece, Ireland and Portugal failed to restore order.”


(emphasis added)

The implication of this objection seems clear.

It should be added that the IMF’s ‘priority creditor status’ by itself already violates the rights of existing Greek bondholders, but obviously the potential recoveries of said bondholders in the event of default would be still lower if the collateral agreement were implemented.

There are therefore two reasons for the continued crash in Greek government bonds:

Finland’s demand for collateral increases the probability that the bailout will not be implemented at all, which will result in a default, and

in the event that the bailout proceeds after a collateral facility acceptable to all euro area members has been established, existing bondholder will recover even less if a default happens down the road anyway.

What a mess.


Miffed Troika

Meanwhile, the ‘troika’ (EU/ECB/IMF) review of Greece’s progress in complying with the bailout conditions – a process that is regularly repeated prior to new loan disbursements – has been interrupted, amid a dispute over ‘fresh gaps opening in Greece’s government budget deficit’.

As the WSJ reports:


“The suspension of the talks in Athens between the government and a group of officials representing the providers of Greece’s bailout cash came, officials said, amid a dispute about how to address new gaps opening up in the government budget deficit.

The Greek side insisted the missed targets are the result of the recession. The troika said recession played a part, but Greece basically didn’t keep up with its commitments, so more measures will be needed to make up for the lost ground,” said a person with direct knowledge of the talks.

“There is a clear disagreement that can’t be bridged today,” the person added.

The talks with the so-called troika—representatives of the International Monetary Fund, European Central Bank and European Commission—began earlier this week and were expected to be concluded by Sept. 5. According to a Greek government official, the delegation is now expected to return in about 10 days, after the government has prepared a draft of its 2012 budget.

On the talks hangs a payout of €8 billion ($11.5 billion) of rescue funds under the €110 billion package arranged last year, needed to ensure the government pays its way. Greece has negotiated a further official rescue package of more than €100 billion, meant to tide it through 2014, which has yet to be formally agreed by lenders.

I expect a hard default definitely before March, maybe this year, and it could come with this program review,” said a senior IMF economist who is keeping close tabs on the situation. “The chances for a second program are slim.”

Failure of Greece to meet its targets, growing reluctance by some euro members to continue lending and the fact that private-sector participation in a second bailout won’t significantly alter Greece’s debt profile are the primary factors, the IMF official said.”


(emphasis added)

This certainly sounds as though the market’s assessment of the situation (i.e., default is all but certain) will turn out to be correct. Note however that the official statement on the interruption of the review makes it sound as though it was all about a tiny technicality not really worth worrying about (‘move along, there’s nothing to see here’).


“A joint EC/ECB/IMF team has been discussing recent economic developments and reviewing policy implementation in the context of the fifth review of Greece’s economic programme. The mission has made good progress, but has temporarily left Athens to allow the authorities to complete technical work, among other things, related to the 2012 budget and growth-enhancing structural reforms. The mission expects to return to Athens by mid-September, when we expect the Greek authorities to have completed the technical work, to continue discussions on policies needed to complete the review.”


In other news, a certain bridge in Brooklyn is up for sale again.

Not surprisingly, Greek government bond yields have continued to soar, with the one year yield jumping by nearly 1100 basis point in Friday’s trading alone, to a new high of 72.04%. The two year yield also jumped to a new high just above 47%, a rise of just a little over 400 basis points on the day. The inversion of the Greek yield curve is becoming ever steeper.


Greece’s one year government note yield jumps to over 72% on Friday – click for higher resolution.


An overview of Greek one, two and ten year government bond yields as of last Friday – click for higher resolution.


EFSF Ratification Trouble & Dangerous Timetables

Recently reports in the media have gone back and forth between stating that Mrs. Merkel faces a potential ‘revolt’ in her own governing coalition against ratification of the latest bailout deal, to stating that she has things well in hand by employing well-worn scare tactics to bring members of parliament into line (the old ‘we shall all perish if we don’t throw even more tax payer money at bankrupt entities’ ploy).

The latest development is that the Free Democrats apparently insist that the German Bundestag needs to have veto power over EFSF decisions in exchange for approving the expansion of the rescue fund. In short, it appears now that the bill’s smooth sailing envisaged only a short while ago may turn out to be nothing but wishful thinking after all.

According to Bloomberg:


“The German parliament must have the right to approve all aid petitions made to the rescue fund and the weight of its decisions to be reflected in the fund’s actions, the newspaper reported today, citing unidentified FDP officials.

If a petition fails to gain a clear parliamentary majority Germany’s representative on the fund’s ruling board must be forced to reject the petition rather than abstain, Bild reported, citing the officials.

The Germany government aims to have the bill to expand the toolbox of the European Financial Stability Facility on the statute books by the end of September.”


Now consider that on September 7, the German constitutional court will issue its ruling on the bailout complaints. As we have noted previously in this context, the vast deterioration in the social mood occasioned by the post bubble secular economic contraction and the fact that the complainants are correct in both their economic and legal assessment of the situation makes a ‘surprise ruling’ much more likely this time around. Specifically, we think it possibly that the court will insist on precisely the type of thing the FDP wants to have: more democratic control of the bailout process through the German Bundestag.

The month of September is in fact home to a great many events that could potentially upset the markets further. The first event that was originally scheduled for September 5 was the conclusion of the ‘Troika’s’ review of the Greek budget. This as we have seen has already been postponed, to devastating effect.

On September 8, we have the next ECB meeting, a meeting that is likely to disappoint, as ECB president Trichet is unlikely to do an immediate about-face and ease monetary policy again after just having hiked rates twice – in spite of the fact that markets are already pricing in renewed easing in view of the recent rapid deterioration in economic growth.

September 9 is the deadline for the planned Greek debt exchange, i.e., the private sector contribution to the bailout, which due to its allegedly ‘voluntary’ nature requires the rigmarole of banks officially ‘expressing their interest in participation’. Greece has let it be known that anything less than 90% participation by creditors would be deemed insufficient for the plan to go forward.

September 15 is the day when the next disbursement of EFSF bailout funds to Ireland and Portugal is due. This is likely to happen without a hitch, but then again, there lately has been quite a tendency for Murphy’s law to strike unexpectedly.

The next FOMC meeting is taking place on September 20-21; we think by that time there could be enough panic in the markets to induce the committee of central planners to go for the pump priming equivalent of ‘shock and awe’ – especially after the truly dismal jobs report released last Friday. As we have noted before, the possibility that the markets will just ‘yawn’ and sell off anyway should not be dismissed out of hand.

On September 29, the German Bundestag will vote on the new EFSF/ bailout ratification. This promises to be quite riveting this time.

What else is going to happen during September? Well, for one thing, Italy must roll over about € 45 billion in debt. That could prove to be quite a problem, especially if market turmoil persists. Italian bond yields are once again soaring, following a decrease in ECB intervention and the Berlusconi government’s recent backtracking on the austerity package. This has led to ECB president Trichet publicly admonishing Italy’s government in an attempt to bring it back into line. According to Bloomberg:


“European Central Bank President Jean-Claude Trichet said Italy must confirm its commitment to the “overall goal” it announced on Aug. 5 to reduce its budget deficit.

“These measures decided by the government in its announcement on 5 August are of extreme importance to rapidly reduce public finance deficits and enhance the flexibility of the Italian economy,” Trichet said in an interview with Il Sole 24 Ore, according to a text published by the Frankfurt-based ECB. “It is therefore of the essence that the overall goal in terms of the public finance improvement that was announced be fully confirmed and substantiated.”

Italian Prime Minister Silvio Berlusconi on Aug. 29 agreed to overhaul the 45 billion-euro ($66 billion) austerity plan of Aug. 5, which had helped persuade the ECB to start buying Italy’s bonds. While the full impact of the changes remain unclear, Berlusconi dropped a tax on the highest earners and limited funding cuts to regional governments to appease the Northern League, a key coalition ally opposed to parts the original plan that aimed to balance the budget in 2013.

Finance Minister Giulio Tremonti said yesterday that a planned crackdown on tax evasion will offset lost revenue from a levy on higher earners dropped from the package. The ECB is watching with “great concern” how Italy progresses with budget cuts, Governing Council member Ewald Nowotny told reporters last night.


(emphasis added)

We believe Silvio Berlusconi is a tough-as-nails politician with no scruples whatsoever. Embarrassment isn’t even part of his vocabulary. Just look at how many legal troubles he has survived and what methods he employed in doing so. As we have previously suggested, he may have simply intuited that he is actually the one who holds all the trump cards in this particular game of nerves. After all, the ECB is likely well aware that if Italy’s bond yields were to exceed the ‘bailout threshold’ level established when the ‘GIP’ trio went belly-up, it will be all over but the shouting. Consequently Berlusconi may be calculating that the ECB will do whatever is necessary to avert this scenario. He may well be right about the ECB, alas he may be underestimating the power of the markets to overrule such interventions.


September Could Be Brutal – And May Produce Buying Opportunities

Speaking of the markets – here is precisely the problem with the timetable we have just outlined. We believe the markets simply do not have the patience to wait and see what may or may not happen. In today’s world of inter- and intra-market hyper-correlation between ‘risk assets’, with a great many large hedge funds already nursing big losses after the plunge in stock markets and commodities during August, there are probably a great many itchy trigger fingers out there.

We keep hearing how a ‘repeat of 2008 is impossible’ and admittedly there are a number of well-reasoned arguments that would seem to favor that view. Primarily we would cite the enormous growth in US money supply that we have recently observed. However, we are concerned by this widespread consensus. Consider that the most recent month for which we have reliable money supply growth statistics is the month of July – a month during which money supply growth went ‘off the charts’ as the saying goes. And yet, the markets for risk assets plunged in July and August. There is no telling how big a lag there will be before the money supply growth shows an effect aside from the one it has already exerted on the gold price.

The question one must ask is this: are the obvious risks (not to mention the unknown ones) adequately discounted already? We would be far more confident that they have indeed been discounted if there were abject fear in the markets. Alas, we do not detect such abject fear as of yet. On the contrary, the vast majority of market commentary seems focused on the ‘dip buying opportunity’. As we have pointed out all year long, indicators of sentiment that have proven long term significance, such as the mutual fund cash-to-assets ratio and total margin debt have been in ‘red alert’ territory for many months. One should thus probably spend more time on pondering what could go wrong than on the alleged dip buying opportunities. However, as you will see further below, we do believe investors should begin to consider the opportunities that may present themselves in European markets over coming weeks.

One of the signs that risk is extremely high is the run-up in CDS on the debt of major European banks. The sovereign debt crisis continues to unrelentingly redound on the fractionally reserved and clearly under-capitalized euro area banks.


A simply arithmetic composite chart (unweighted) of CDS on BBVA, Deutsche Bank, SocGen, BNP Paribas, Intesa Sanpaolo, Monte dei Paaschi di Siena, and Unicredito. As can be seen, these CDS prices are way above their 2008/9 crisis highs by now – click for higher resolution.


As we have noted on several occasions, interbank and wholesale funding is increasingly drying up in the euro-area. The ECB is taking over an ever greater share of bank funding as silent bank runs are engulfing banks in the PIIGS nations, with more and more banks seeing questions raised about the counterparty risk they pose. What if the banking system suffers a serious seizure that requires even more forceful, panicked ad-hoc measures by the ECB to keep the system of payments going? Can anyone rule something like that out if e.g. Greece were to actually default? Is this risk adequately discounted? Of course we don’t know whether it is or isn’t, but we kind of doubt it. Meanwhile, euro basis swaps continue to indicate that stresses in connection with dollar funding in the euro area banking system are worsening.


Three month, one year and five year euro basis swaps. Note the continued deterioration in the shorter term swaps to levels associated with previous iterations of the crisis – click for higher resolution.


In addition to the foregoing we would note that the charts of most stock markets simply look terrible. Germany’s DAX index specifically is best described as a horror-show. We have previously warned that the consolidation following the initial weave of heavy selling looks like some sort of running correction. It still looks that way, although no new low has been produced yet, so alternative (and hence more short term bullish) interpretations can not be ruled out yet. Nonetheless, this is an ugly chart no matter which way one slices it. The biggest concern must be the weakness exhibited in the recent bounce attempts and the ease with which very large sell-offs have tended to occur. For instance, Friday’s decline doesn’t look like much on the chart, but it was actually a quite considerable plunge of 3.4%.


The mother of all ugly charts at the moment – Germany’s DAX index – click for higher resolution.


Other European stock markets look only mildly more encouraging. In fact the best things one can say about these markets at the moment is that they haven’t made new lows yet and that they have declined a great deal already. This leaves the possibility of a bigger bounce open, if only due to severely oversold conditions. Alas, as we have mentioned before, neither ‘oversold’ nor ‘cheap’ are sufficient conditions to avert a bigger sell-off when things keep going wrong in what is already an environment of frayed investor nerves.


Italy’s MIB Index actually looks ever so slightly better to us than the DAX, but obviously not by much – click for higher resolution.


A weekly chart of the MIB shows it is not very far from the panic low of early 2009. The decline from the bull market high amounts to 66% – a major bear market by any reckoning – click for higher resolution.


A long term log chart of the ATG shows that is has now declined by 83.5% from its all time high in 2007. In short, this is now one of the biggest bear markets in all of history. A major buying opportunity is probably not too far away, more on this follows below – click for higher resolution.


Some Remarks on Bear Market History and Euro Area Money Supply

It should be noted in the context of the above that many European stock markets have by now declined by so much that patient long term investors should indeed begin to think about the buying opportunities that may present themselves in coming weeks. There is however a caveat here that we want to briefly discuss. In order to take advantage of the opportunities that are available close to major bear market lows, one must be aware of certain aspects of how such lows tend to be put in. A very good example that can serve as a comparison to what is currently happening in the Greek stock market is the bear market in US stocks from 1929 to 1932. One salient aspect of that particular waterfall decline was that the final leg down was the by far greatest of the entire bear market in percentage terms.

The final plunge began shortly after the NYSE introduced a ban on short selling in February of 1932 – does that sound familiar? If not, it should. Currently there is a short selling ban on financial stocks in force in France, Italy, Spain and Belgium, which is scheduled to end on October 1. However, since the ban has already been extended once, there is no guarantee that it will really be lifted at the appointed time.

Below is a chart illustrating the above mentioned final leg down in 1932 as well as the subsequent recovery in terms of the Dow Jones Industrial Average. The short selling ban that preceded the plunge was part of president Hoover’s war on the markets. Hoover was the first unalloyed economic interventionist in US politics and he was convinced that Wall Street was ‘out to get him’ and that the bear operators in the stock market had to be stopped. Not surprisingly, the decree had the exact opposite effect of that intended.


In February of 1932, the NYSE introduced a ban on short selling. As can be seen, this led to a vigorous short term bounce, as shorts were forced to cover. Once their short covering activities were finished, the market resumed its decline. From an interim high of about 90 points on March 3 1932, the DJIA plunged to about 40 points in early July of 1932 – a decline of 55% in the space of a mere four months. This was followed by an equally vigorous rebound over the following three months – click for higher resolution.


Now consider what this 49.31 point decline between March and July 1932 meant relative to the high of 381.17 points the DJIA had reached on September 3 of 1929. Relative to this high, it represented only the final 12.94% leg of the entire decline – but relative to its interim high in early March of 1932 it was a 55% decline. A buyer in early March of 1932 may well have thought that with the market down 76.4% from its 1929 high he was surely looking at bargains. In fact, the dividend yield of the 30 DJIA stocks had rarely been higher. As it turned out, the dividend yield eventually went above 11% in July of 1932. Our hypothetical buyer of bargains would have required a very strong stomach as his stocks plummeted by another 55%. However, a few years later, the subsequent bull market of 1932 to 1937 would have ‘bailed him out’.

The point of all this is the following: when a market reaches levels that suggest a major low may be close, it is certainly a good time to think about picking up bargains. However, one must be aware that the final phase of a decline – the capitulation stage – is usually the most brutal part of the bear market during which large additional percentage losses are likely to occur. Since it is not possible to tell with certainty in advance where the ultimate low will be, the best method is to first pick the stocks that look like the babies that have been thrown out with the bathwater, and then gradually buy into them as the final part of the decline is underway.

Another pertinent example is the final leg down in the long bear market in gold stocks that was put in place between 1999 and 2000. While gold itself merely retested its 1999 low in early 2001, the gold stocks fell considerably more between 1999 to 2000. Of course this was also the best time to begin buying them, but one had to do spread one’s buying out in order to get good average entry prices. In addition, a fair amount of patience and conviction was required. Anyone piling in and buying a full position in 1999 would have watched the value of his position losing quite a bit in spite of the fact that the gold price itself did not fall below its 1999 low in the course of the 2001 retest.


The HUI index from 1999 to its absolute bear market low in November of 2000. Note the enormous additional percentage that was lost in gold stocks in spite of the fact that gold did no worse than retesting its 1999 low in April of 2001. Note that the price of gold was actually slightly higher in November of 2000 (at about $260) than at the 1999 low, and yet the HUI index lost nearly 50% of its value over the same period. Today the HUI index stands at 618 points, so buying it in this time period was of course a very good idea – click for higher resolution.


For comparison purposes, here is the gold price over the same time period:


At the summer/fall 1999 low gold traded just above $250/ounce, while the HUI stood at 65 points. In November of 2000, gold traded at just above $260/ounce – but the HUI had fallen to just 35 points concurrently, an all time low – click for higher resolution.


In summary, if one is thinking about taking advantage of the euro area crisis in order to pick up valuable assets cheaply, one must consider the trials and pitfalls involved with buying at the tail end of a major bear market. Investors need to exercise patience and have a long time horizon to give these investments time to bear fruit. Note that the intensity of the current crisis is not an impediment to such a strategy. Quite on the contrary, it adds to the strategy’s viability.

In the meantime, Michael Pollaro has updated euro area money supply data for the month of July. They make for grim reading for stock market bulls. While there was a brief spurt in the annualized growth of euro area money TMS (‘true money supply’) in June, this has reversed markedly in July.

In brief, the monthly annualized growth rate of euro area TMS clocked in at minus 4.7% in July. The broad aggregate M3 was shrinking at a more modest 0.6% annualized. Year-on-year, euro area TMS growth was a mere 1%, while M3 has grown by 2.5%. No-one should be terribly surprised that the crisis is coming to a head at this time and that economic activity has lately been falling off a cliff. Note that the source of the money supply deflation in July was the commercial banking system.


Euro area money supply developments via Michael Pollaro. This looks quite negative for ‘risk assets’ in the euro area in the near term – click for higher resolution.


US Stocks and Gold

Friday’s unemployment data were quite bad, as was to be expected. However, the data were actually even worse than expected by mainstream economist estimates. Even though expectations had been ratcheted down prior to the release, it still managed to underwhelm these lowered expectations by showing zero growth in payrolls overall.


Growth in non-farm payrolls disappears entirely in August – click for higher resolution.


Give the ‘negative surprise effect’, the stock market promptly extended its decline of Thursday and once again fell sharply. Stock index futures already indicated a weak opening in the wake of the continuing travails in Europe, but the unemployment report was the ‘coup the grace’. Although the weak jobs data of course all but guarantee that the Fed will announce major new monetary pumping measures at the September FOMC meeting, the market seems more concerned about economic weakness right now and the effect it will inevitably exert on corporate profits. Corporate profit margins are at an all time high relative to GDP, a situation that is bound to mean revert in any case. This combined with a weakening of economic growth is certainly weighing on stocks. As we have pointed out before, if the economy’s pool of real savings is in trouble, then it won’t matter much how much more monetary pumping the Fed plans to shower us with – stocks may well decline anyway in that case.

We said previously that we ‘don’t like the looks of this chart’, referring to the SPX at the top of the recent rebound. Nothing has happened since then to alter that opinion. We still don’t like how the chart looks.


The SPX daily, with lateral support (blue dotted line) and resistance levels (red dotted lines). We still don’t like the looks of this chart – click for higher resolution.


A ‘heat map’ of Friday’s action in the S&P 500 shows that only the lone gold stock in the index managed a respectable increase during Friday’s equal opportunity massacre.


The ‘heat map’ of the SPX for Friday. The only green spot was Newmont Mining (NEM), the lone gold mining stock in the index – click for higher resolution.


In all likelihood the S&P 500 will soon retest the lows of August. How it handles this retest – if it indeed happens – will tell us much about what to expect for the rest of the year.

Gold meanwhile reacted exactly as it should to the weaker data – by rallying smartly. Gold is evidently beginning to discount the next round of monetary pumping, which incidentally will happen at a time when money supply growth in the US is already very strong.


Gold rises strongly on Friday – it is now only a stone’s throw away from a new all time high. So far it looks as though the ‘grave dancers’ were once again too early – click for higher resolution.


On Friday, the HUI index of unhedged gold stocks gapped above the resistance level that has been the upper boundary of a 10 months long trading range. While we can not be sure yet if this breakout will hold, for now it is what it is – a new high, which means there is no longer any resistance level on the chart. Note also that the advance since the August interim low has negated a previously developing head & shoulders topping pattern. Per experience, it is often a very bullish sign when a seemingly bearish pattern is negated – click for higher resolution.


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, mainly of the euro area and neighboring CEE sovereigns. Prices in basis points, color-coded where applicable. As can be seen, the situation has continued to worsen on Thursday and Friday. Notably, CDS on Italy’s debt are back at almost 400 basis points while yields on Italian government bonds have clearly reversed and are once again rising strongly (note, the snapshot of CDS is only including Thursday’s close, but all have increased further in Friday’s trading). The market seems mostly focused on euro area CDS right now, with others still pulling back in a triangle. Alas, all these charts continue to look bullish.

Given the huge debt rollovers looming in September, Italy’s bond yields could easily rise back to their previous high and perhaps even higher. Much will of course depend on how much more ECB intervention in Italian bonds takes place over coming weeks. Given the recent spat over Italy’s government’s backtracking on its austerity plans, the ECB may actually hold off on further intervention in order to force compliance. Note that Spain too has a large amount of debt maturing in September and October (the bulk of Spain’s rollovers will be in October).


5 year CDS on Portugal, Italy, Greece and Spain – note that in Friday’s trading, CDS on Italy rose further to 399 basis points – click for higher resolution.


5 year CDS on Ireland, France, Belgium and Japan – apart from CDS on Ireland’s debt, all are moving higher again – click for higher resolution.


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


5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – click for higher resolution.


5 year CDS on Romania, Poland, Slovakia and Estonia – click for higher resolution.


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


5 year CDS on Germany, the US and the Markit SovX index of CDS on 19 Western European sovereigns. The ascending triangle in the SovX suggests that euro area CDS on sovereign debt overall are bound to break to higher levels – click for higher resolution.


10 year government bond yields of Ireland, Greece, Portugal and Spain. Greek yields are at a new high, while Spain’s have clearly begun to turn back up. The recently more positive trend in Irish and Portuguese bonds is still alive, but per experience correlations tend to increase again when crisis conditions worsen – click for higher resolution.

10 year government bond yields of Italy and Austria, UK gilts and the Greek 2 year note. Greek short term note yields have advanced into ‘beyond good and evil’ territory. Note the spirited rise in Italian yields following the recent retest of the breakout, while the ‘safe haven bonds’ are once again attracting buying – click for higher resolution.

The three month euro basis swap remains well in ‘crisis territory’. This indicates that dollar funding problems in the euro area banking system persist – click for higher resolution.


One year euro basis swap – breaking below the lows of 2010 – this is obviously not good – click for higher resolution.


5 year CDS on the ‘Big Four’ Australian banks – currently in pullback mode – click for higher resolution.



As this recent article by Ambrose Evans-Pritchard reports, the deposits of foreign institutions at the Fed have markedly increased in recent weeks. This buttresses our contention that the recent sharp increase in US money supply growth may be partly explicable by ‘dollars returning home’ as institutions pull back from funding the dollar liabilities of euro area banks and worries about counterparty risk in the euro area banking system increase. As Evans-Pritchard writes:


“Central banks and official bodies have parked record sums of dollars at the US Federal Reserve for safe-keeping, indicating a clear loss of trust in commercial banks.

Data from the St Louis Fed shows that reserve funds from “official foreign accounts” have doubled since the start of the year, with a dramatic surge since the end of July when the eurozone debt crisis spread to Italy and Spain.

“This shows a pervasive loss of confidence in the European banking system,” said Simon Ward from Henderson Global Investors. “Central banks are worried about the security of their deposits so they are placing the money with the Fed.”

These dollar accounts are just over $100bn (£62bn) and are small beer compared to the vast sums invested in bonds as foreign reserve holdings. Yet they serve as stress indicator, reflecting the operating decisions of the world’s top insiders.” The dollar data refers specifically to reverse repurchase agreements.

Lars Tranberg from Danske Bank said European banks are reduced to borrowing dollar funds for “a week at a time” rather than the usual six to 12 months. “This closely resembles what happened in late 2008, though the difference this time is that the major central banks have dollar swap lines in place. If the dollar funding markets completely freeze up, the European Central Bank can act as a backstop.”

Mr Tranberg said dollar deposits of US banks have increased by $400bn since mid-June, mostly offset by dollar reductions in Europe.”


(emphasis added)

Well, $400 billion are certainly not ‘small beer’ and likely account for a considerably percentage of the increase in uncovered money substitutes held at US commercial banks in July and August.


Charts by: StockCharts, Bigcharts, Bloomberg, WSJ, St. Louis Federal Reserve Research, The




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