The Non-Bazooka Is (Not Really) Ready

The big 'news' today is that the euro area finance ministers have finally put the finishing touches on the very construct that everybody already knows won't work – namely the 'new and improved' EFSF.  It took them long enough, or to be more precise, it took them too long. As has been the case throughout the crisis, the various decisions emanating from the eurocracy come with such a long delay that they have already been overtaken by events – overruled by the market-place, so to speak.

So they now have finally constructed their vaunted 'bazooka' – probably just in time for it to sink without a trace. In order to give the bailout fund more heft, they are also pleading for increased involvement by the IMF (we're not sure if the IMF has been fully apprised about this turn of events yet, but given that French ex-finance minister Christine Lagarde heads the IMF these days, one presumes it has). 

According to Bloomberg:

„Euro-area finance ministers approved enhancements to their bailout fund while backing off from a target for its firepower and seeking a greater role for the International Monetary Fund in fighting the debt crisis.

The finance chiefs of the 17 nations using the euro agreed to work on boosting the resources of the IMF so it can “cooperate more closely” with the European Financial Stability Facility, Luxembourg’s Jean-Claude Juncker told reporters late yesterday in Brussels after leading the meeting.

“It’s very important that the IMF globally will increase its resources either by raising its capital or by bilateral loans so that it can lend more money to euro-zone countries in need,” Dutch Finance Minister Jan Kees de Jager said in an interview with Bloomberg Television after the meeting. “If we open the IMF effort, that will be sufficient together with the leverage options in the EFSF.


(emphasis added)

'Sufficient' for what exactly? For removing the fundamental design flaws of the euro? For rescuing the floundering 'spend now, pay never' welfare state model constructed by the European socialist elite? De Jager didn't say.

As far as the IMF is concerned, we would like to once again point out that it indeed lacks the resources to make a dent in the run on Italian and Spanish government bonds. It has less than $400 billion in loanable funds at its disposal in toto.  That's the amount of money European bondholders are these days apt to lose in a few weeks of panic selling. The IMF can of course not lend  all of this money to Europe, since then it would be bereft of funds to deal with whatever other crises are likely to pop up in the wake of the ongoing – and steadily worsening – economic contraction.

So how exactly is the IMF going to 'increase its resources'? As we have mentioned, there is really only one way this can be done: lending by the ECB, with money created from thin air. All the non-European IMF members will rightly balk at being asked to contribute to a rescue everyone knows Europe should be able to stem by itself.

However, the eurocrats do have a means of blackmailing the world, namely the fact of 'mutually assured destruction'. This becomes clear when considering a chart recently published by the Bank for International Settlements (BIS) in Basel. The chart depicts the interconnectedness of the global financial system. The thicker the lines, the bigger the amounts at risk.



The spiderweb of global financial interconnectedness. If one of these dominoes tumbles, all of them will – click for better resolution.



It should be clear that it is not the interconnectedness as such that creates the biggest problem: it is the fact that at the root of this huge web of financial claims and counterclaims we find a fractionally reserved banking system the liabilities of which are largely uncovered – i.e., the great bulk of the money supply that is supposedly available 'on demand' if depositors come to ask for payment in the form of money proper (banknotes in the fiat money system) is in fact not covered by standard money.

This is why the game of chicken currently playing out in the euro area is considered to pose a global danger. It could well mean that the end-game for the system as we know it is approaching – a prospect not relished by those who profit most from the system's current configuration.

Bloomberg continues:

“After a series of stop-gap accords failed to protect Italy and Spain from surging bond yields, the euro-area ministers are under growing pressure from U.S. leaders and international financial markets to find ways to boost the EFSF’s effectiveness. They agreed on a plan to guarantee up to 30 percent of new bond issues from troubled governments and to develop investment vehicles that would boost the facility’s ability to intervene in primary and secondary bond markets.

EFSF Chief Executive Officer Klaus Regling said it is “impossible to give one number” for the total firepower of the fund, backing off an earlier goal of 1 trillion euros ($1.3 trillion). “Market conditions change over time,” he said.

Juncker said the EFSF’s capacity will be “very substantial” and will be supplemented by the IMF. The ministers “agreed to rapidly explore an increase of the resources of the IMF through bilateral loans,” Juncker said, “so that the IMF could adequately match the new firepower of the EFSF and cooperate more closely with it.”

European Union Economic and Monetary Affairs Commissioner Olli Rehn said the issue “needs to be discussed with the IMF and this work is in progress.” Neither Rehn nor Juncker named who might provide the loans. “We are together with the IMF consulting contributors through bilateral loans,” Rehn said.

The Europeans are “not there yet” in terms of fleshing out their plan enough for emerging-market nations to pledge funds to the IMF that would then aid the euro region, said Callum Henderson, global head of foreign-exchange research in Singapore at Standard Chartered Plc. “It does appear that we are making progress — the question is are we making progress fast enough.”


(emphasis added)

That's more like it! A 'work in progress', that is 'not really there yet' – this is what we have come to expect from euro area summits.

Here is a chart of the spread between Italy's and Germany's 10 year yield. Does anyone think this looks like a chart that's going to wait for this 'work in progress' to be concluded?



The spread between Italy's and Germany's 10 year bond yields. Evidently the eurocrats are not au fait with technical analysis, otherwise they'd be in more of a hurry. The recently built symmetrical triangle is a high probability bullish continuation formation, usually followed by a thrust in the direction of the trend. Keep those hatches battened!



Meanwhile, the EU's chief bailout bureaucrat Klaus Regling admitted that the EFSF seems unlikely to achieve miracles – an opinion with which independent observers evidently agree wholeheartedly:

“The EFSF bond guarantees and investment vehicles can run simultaneously and could be functioning by early next year, according to a document released by the fund. “Many investors are interested and will participate if we have a solidly commercial product,” Regling said. “But don’t expect massive inflows immediately. The needs will come over time.”


“These decisions have clearly enhanced the capacity and flexibility of the EFSF,” said Charles Dallara, head of the Institute of International Finance, which represents more than 450 financial companies. “The EFSF can now issue short-term bills and use government bonds it may purchase on secondary markets for repo transactions.”

Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London, said the moves represent “some marginal technical changes regarding intervention in primary and secondary markets, but overall it’s very similar” to previously published documents on the EFSF’s role. “Dec. 9 might have more meat, hopefully, otherwise markets will be yet again disappointed.”

Apparently Regling thinks he needs to dampen our expectation, but that is really not necessary. Since the current incarnation of the EFSF couldn't even sell € 5 billion in bonds for the Ireland rescue – with Ireland the current poster boy for 'bailout success' – we feel pretty sure that there won't be 'massive inflows immediately'. The main question is probably if there will be any inflows at all.


Clever Formulas Hatched

Meanwhile, Bloomberg also notes that the ground is being prepared for more 'ECB support' – and given the fact that the ECB and the IMF continue to be mentioned in the same breath, we remain fairly confident that 'Plan B' is based on circumventing the statutory limitations of the ECB by getting it to finance a bailout via the IMF detour. Consider the wording of the following comments:

“Germany is pushing for governance changes at next week’s summit that would tighten enforcement of budget rules, a move that might make it easier for the European Central Bank to play a bigger part in supporting euro-area nations.

Greater roles for both the ECB and the IMF are “on the table,” Belgian Finance Minister Didier Reynders said as he left yesterday’s meeting.

“The EFSF alone will not be able to solve all the problems,” Luxembourg’s Luc Frieden said. “We have to do so together with the IMF and with the ECB in the framework of its independence.”

The ministers have started talks on channeling ECB loans to cash-strapped euro nations through the IMF, aiming to bring the central bank on to the front lines without violating its ban on direct lending to governments, according to two officials familiar with the discussions.

Well, there you have it – the printing press is being readied for deployment, as soon as Germany has extracted its pound of flesh. Note also Irish finance minister Noonan's comment:

“Four weeks after taking over from Jean-Claude Trichet, ECB President Mario Draghi hasn’t tipped his hand about a possible role for the central bank, apart from saying the ECB’s 18-month- old bond-buying program is temporary and limited.

“From our perspective, we see how the Bank of England operates, and we see how the Fed operates, but I understand it’s not legally possible for Frankfurt to operate in the same way,” said Irish Finance Minister Michael Noonan as he arrived at yesterday’s meeting. “So we’ll have to see if somebody has come up with a clever formula to allow that.”

See, all it takes is a 'clever formula' – which should be no surprise, in fact, at times even not-so-clever and rather clumsy 'formulas' have been used to get around the legal limitations imposed by EU treaties. At times the treaties are simply ignored – such as when France and Germany violated the Maastricht limits on cumulative public debt to GDP ratios in 2002-2003 and no sanctions whatsoever were imposed as a result – at times existing paragraphs are simply  bent in a way that clearly is against their spirit, such as the Lisbon treaty's provision for mutual aid in case of natural catastrophes. Its wording is just vague enough to allow for the back-door introduction of a transfer union, as represented in the concrete case by the Greek (and later Irish and Portuguese) bailout. No-one's going to send a gunship to Brussels and demand that everything is handled in an above-board fashion after all.



Italy's 10 year yield as of Tuesday's close (today up another 6 basis points at the time of writing) – better hurry up with that 'clever formula', or it's 'game over' – click for better resolution.



It is important to realize that the idea that the ECB should be enabled to emulate the Fed and the BoE in implementing a mild form of Chartalism is not only not going to solve the basic problem, it is going to make it worse. It is certainly true that the markets are at present giving the money printers a lot more rope to hang themselves with, but that doesn't represent proof that the method 'works'. It merely postpones the day of reckoning, which will be all the more dramatic when it comes. There are certainly a number of people in the ECB's hierarchy who are aware of this fact, hence the central bank's immense reluctance to go down this path. On the other hand, one should not underestimate a bureaucracy's willingness to choose expediency over principle when its own survival is coming into doubt.

It has also come to light that in spite of the official denials regarding involving the IMF in a rescue of Italy and Spain, the rumors just won't die – so there appear in fact to have been talks to this effect, although the IMF and the governments involved continue to deny it.

According to Reuters:

Italy has had preliminary discussions with the International Monetary Fund about financial support to cope with the euro zone's debt crisis, possibly co-funded by national European central banks, but no decision has been taken, several sources close to the situation said. New Italian Prime Minister Mario Monti was briefing euro zone finance ministers on his fiscal plans on Tuesday but the sources said no formal request for IMF assistance was expected before he presents his budget to the cabinet on December 5.

In Spain, the centre-right People's Party (PP), which won a November 20 general election, is considering seeking international aid as one option for shoring up Madrid's public finances, according to sources close to the party. The PP and the outgoing Socialist government denied there were any such talks. The situation is complicated by the fact that centre-right Prime Minister-elect Mariano Rajoy has not yet formed his government and will only take office around December 20, although he is expected to outline key economic plans on December 8.

A source familiar with both sides of exploratory talks between Italy and the IMF said high level discussions had been under way for weeks but had accelerated since last Wednesday, when Germany made clear the European Central Bank could not directly assist Rome.

"Discussions are currently around a 400 billion euro contingency package. Italy has not filed a request but things are building in that direction," the source said.

That is more than the roughly $380 billion which the IMF currently has available to lend to all countries, although talks are under way among the G20 major economies on boosting the Fund's resources. An IMF spokesman said in a statement: "The IMF wishes to reaffirm that there are no discussions with the Italian nor Spanish authorities on any form of IMF financing."

The official denials are of course entirely meaningless. In fact, the more vehement the denials, the more likely it is that the reports are true. One need only remember the denials of the Portuguese and Irish governments regarding their impending bailouts, which were repeated until literally a few hours before their bailout requests to the EFSF were made public.  Obviously neither Italy nor Spain can be 'rescued' by the lame EFSF bazooka, so it certainly makes sense that they would talk to the IMF.

Meanwhile, the WSJ's take on the euro area talks on the EFSF – aptly entitled 'Euro Zone Falls Short On Fund', contains a few interesting tidbits as well, including the fact that the reluctance of certain euro area governments to call on the ECB to deploy the printing press is giving way quite fast now. At the moment only Germany and the Netherlands still seem to be holding out:

“European politicians have for months been reluctant to call publicly on the ECB to take a larger role.

The central bank is independent of the euro-zone governments, and it guards that status fiercely. With a lack of private-market interest in financing weak euro-zone countries, the ECB's virtually unlimited firepower—it can, after all, print euros—is seen by many analysts and economists as the only viable solution. Now, the reluctance to call for help is ebbing away.

Finland's finance minister said the bloc will have to look to the ECB as a last-resort option "if nothing else works," and the Belgian finance minister said ministers would "put on the table some proposals" to give the ECB and the IMF a more active role. The IMF is already a major player in the euro-zone rescue effort. It is providing €30 billion of Greece's €110 billion bailout, one-third of Portugal's €78 billion bailout, and a chunk of Ireland's aid as well.

However, it doesn't have the resources available, on its own, to lend hundreds of billions of euros to Italy. Yet national governments still aren't singing the same tune on whether the ECB should ramp up its printing presses. Resistance to the proposal is strong in Germany and the Netherlands.”


(emphasis added)

Another interesting tidbit was provided by Greek central bank governor George Provopoulos, who highlighted the flight of deposits from the Greek banking system – which has turned the Greek monetary backdrop into one of outright deflation (monetary deflation is now taking hold in all of the PIIGS to varying extents – with Greece and Portugal seeing the fastest declines in their narrow money gauges M1).

“Greek central bank governor George Provopoulos warned that outflows of deposits from Greek banks were accelerating. The loss of close to 7% of total Greek bank deposits over two months suggests confidence among Greeks is waning that the country can surmount its crisis while remaining in the euro zone.

"September and October were two very bad months…we saw a [deposit] outflow on the order of €13 billion to €14 billion. That is a very big number. Likewise, in the first 10 days of November, that rate of outflow continued," Mr. Provopoulos said.”


(emphasis added)

This is an important facet of the crisis, as it will provide the ECB with an additional fig leaf to justify more monetary pumping measures. Monetary deflation in the PIIGS is accelerating – however, ironically, 'price inflation' continues to be well above the ECB's target range, so the central bank is faced with quite a conundrum here (more on this further below).

Banking System Troubles Intensify – SMP Sterilization Fails

The Bloomberg article linked above also mentions that there is now a debate over governments – once again – guaranteeing the debts of banks:

“The euro-area ministers will be joined today by their counterparts from the rest of the 27-nation EU and will seek agreement on how to temporarily guarantee banks’ bond issuance in order to improve funding conditions for lending. EU leaders agreed last month to provide the guarantees as part of a set of measures to restore investor confidence in banks.”

Yesterday euro basis swaps once again plunged deeper into negative territory, highlighting the growing problems the euro area banks face in connection with the funding of their dollar assets.



Three month, one year and five year euro basis swaps continue to plunge deeper into negative territory, as the cost of dollar financing on the interbank lending market soars – click for better resolution.



A long term chart of euro basis swaps shows that they are now well in the territory last seen during the worst moments of the 2008-2009 financial crisis – click for better resolution.



Concurrently it became known that the weekly deposit tender by the ECB that is supposed to sterilize the bond purchases made in the course of the 'SMP' (the ECB's bond market manipulation program) failed to attract a sufficient amount to cover the whole size of the program. It fell short by € 9.5 billion. To be sure, that is not an immense amount and things could be back to normal at next week's tender, or could be rectified with an additional tender. Alas, it certainly reflects the growing stresses the banking system is facing. As Marketwatch reports:

“The European Central Bank on Tuesday failed to fully offset its purchases of euro-zone government bonds through a weekly money-market operation, highlighting growing tensions in Europe’s banking system as institutions scramble for cash.

The ECB drained 194.2 billion euros ($259.2 billion) from the financial system at its weekly tender. That’s short of its target of €203.5 billion, which is the total amount of government bond purchases settled by the central bank since it launched its bond-buying program in the wake of the Greek bailout in 2010.

The ECB offsets, or “sterilizes,” its bond purchases at a weekly operation conducted each Tuesday in which it tenders for seven-day deposits. By doing so, the ECB ensures the bond purchases don’t add to euro-zone money supply.  The tender saw 85 banks offer deposits, with the ECB paying a marginal rate of 0.62%. The euro trimmed gains after the tender but remains up 0.3% versus the dollar at $1.3331.  Failure to fully sterilize its bond purchases would basically amount to the ECB printing new money to fund the purchases, a practice it has so far steadfastly refused to contemplate despite increasing pressure from some euro-zone politicians for the central bank to take on a role as a lender of last resort to sovereign countries.

Piet Lammens, fixed-income strategist at KBC Bank in Brussels, however, downplayed any monetary-policy implications of the failure, but said the event underlined growing stresses in the interbank market as European banks increasingly hoard cash.

While banks were reluctant to make seven-day deposits, many of the funds will likely still end up parked at the ECB in the central bank’s overnight deposit facility, he said. The fact that institutions appear increasingly willing to accept a lower rate — the overnight facility pays 0.5% — “shows there is a lot of stress in funding markets,” he said.

Others argued that the failure could prove to be a turning point in the ECB’s handling of the debt crisis.  If the central bank doesn’t step in with an additional tender aimed at mopping up the leftover liquidity, “then we have to figure [ECB President Mario Draghi] is prepared to accept the monetization of debt and is ready to take on the German view about printing money via open-market bond purchases,” said Carl Weinberg, chief economist at High Frequency Economics, in emailed comments.

For his part, Draghi, who took office on Nov. 1, has maintained the line that the bond-buying program remains temporary and limited in scope.

There are plenty of signs of stress in the European interbank lending market. The ECB said 192 banks lined up to receive seven-day loans totaling €265.5 billion at its main refinancing operation on Tuesday, the highest total in more than two years.


(emphasis added)

As we have pointed out before, the ECB can not 'force' banks to deposit funds with it via the weekly deposit tender. We speculated that the ECB rate hikes earlier this year were in fact inter alia tied to ensuring the success of this draining exercise (as the interest rate offered plays a crucial part in whether banks use the deposit facility or not).

However, it is clear that the troubles of the euro area's banking system are mounting by the day. The attempts to sell assets in order to achieve the new 'core tier one' capital ratios appear to be failing spectacularly. As revealed by the International Financing Review:

European banks are being forced to abandon their efforts to sell off trillions of euros worth of loans, mortgages and real estate after a series of talks with potential investors broke down, leaving many already struggling firms with piles of assets they can barely support.

Lenders have instead turned their attention to reducing the burden of carrying such assets over months and years, with many looking at popular pre-crisis “capital alchemy” arrangements to minimise capital requirements and boost their ability to use the assets to tap central banks for cash.

Deadlocked talks with potential buyers – a mix of private equity firms, hedge funds, foreign banks and insurers – show little sign of making breakthroughs, say bankers taking part in those negotiations, with the stalemate threatening to block the industry’s ability to save itself from collapse through a mass deleveraging.

“European banks have spent far too long saying everything is fine, when it really isn’t,” said one banker at a US bank who has been advising European clients on their options. “They are slowly realising that they just won’t be able to do what the market is expecting. We are edging slowly closer to the depths of the crisis.”


“Banks are feeling pain on both sides of the balance sheet,” said Alberto Gallo, head of European credit strategy at RBS. “On the one side you have a funding squeeze with banks unable to raise cash in the capital markets. At the same time, many of the assets they hold are deteriorating in quality.”

“Banks need to reduce their balance sheets as much as €5trn in assets over the next three years or so,” he added. “The problem is that there just aren’t enough buyers. Most banks will be forced to hold on to much of this stuff to maturity, which will affect their ability to lend and impact on the real economy.”

People involved in asset sale talks say price is the major sticking point. Lenders want only to sell higher-quality assets near to par value so as to avoid huge write-downs, which would erode capital further. By contrast, potential buyers want high-yielding investments and are offering only knock-down prices.


There is also a vast overhang of unsold assets from the initial part of the crisis. Many banks such as Commerzbank, RBS, WestLB and even the Irish government set up legacy units – or bad banks – that were charged with winding down and selling those assets. That process is still ongoing.

“Selling assets is a positive to announce, but it’s going to be very challenging for all the banks that have announced asset sales to get them done,” said Marc Tempelman, head of EMEA financial institutions capital markets and financing at Bank of America Merrill Lynch. “Everyone is selling similar assets.”

He added: “Many banks in Europe have been looking to sell assets for the past couple of years. If those disposals haven’t been closed in better markets, what makes anyone think they can do it now in larger amounts and much more volatile markets?”


That has prompted banks to turn to more creative solutions, with some now looking at what one banker termed as pre-crisis “capital alchemy” arrangements to reduce capital needs. Such methods can also in some cases make assets which banks hold to maturity eligible for ECB repo operations.

Securitisation is at the heart of such arrangements. Assets with low ratings are pooled together into diversified portfolios in order to attain a higher rating. The resulting asset requires less cash and as a result of the higher rating can be more readily pledged to the ECB or to other banks to borrow against.


Still, the practice is not a panacea to banks’ asset and liability problems. Although it can open the door to using ECB repo facilities by making collateral meet strict eligibility criteria, assets pledged are still subject to a haircut, meaning banks cannot borrow enough to fund the asset in question.

Use of the facility is surging, nevertheless. ECB lending to banks spiralled this week, with 178 lenders requesting €247bn in one-week loans, the highest in two years.”


(emphasis added)

The growing sense of panic is palpable. As we have pointed out before, euro area banks are not only saddled with a big problem due to the sovereign debt crisis, they are also saddled with an enormous amount of US housing bubble legacy assets, which continue to deteriorate.

They have left dealing with these assets for too long, in the mistaken assumption that if they were to hold them to maturity – which allows the mark-to-market losses not to be recognized –  they could escape the market's attention. Evidently this idea was sorely mistaken. This in turn makes issuing new shares to raise fresh capital an exercise that is horrendously expensive for existing shareholders, who would get massively diluted. The banks are really between a rock and a hard place now.

Meanwhile, in a somewhat  hilarious recent development, various euro area governments are leaning on their commercial banks to buy more of their wilting bonds. As the WSJ reports:

“Some European nations, struggling to find buyers for their bonds, are pressuring their own already-stressed banks to fill the gap by acting as lenders of last resort—in certain cases, pushing the amount of risky European debt on those institutions' books even higher.

Italy and Portugal, among other European governments, are leaning on their banks to continue buying—or at least to stop selling—government bonds, according to people familiar with the matter.  Meanwhile, in Spain and other European countries, the quantities of loans banks are doling out to local and national governments have been rising sharply.”

And so the vicious cycle between governments and the banking cartels in Europe is egged on further. We have governments discussing how to once again bail out their banks, while at the same time these governments lean on the banks to help bail out the governments. How exactly is that supposed to work?



The Euro-Stoxx Bank Index. The third re-test of the lows may finally bring a relief rally, but a huge amount of damage has been done – click for better resolution.



ECB's Easing Measures Complicated By Data

Yesterday's news that 'inflation' – i.e., the rate of change of CPI – has hit a new high in Belgium, was a precursor to today's euro-area wide CPI inflation estimate, which showed that consumer prices continue to refuse to turn down.

'Belgian Inflation Soars', the WSJ reports. 

“Belgium's inflation rate rose to its highest level in almost three years in November, with the consumer price index rising 3.85% in November from the year earlier, the Belgian economy ministry said Tuesday.

The November increase compares with annual inflation of 3.57% in October. It is the highest annual increase since October 2008 and comes despite Belgian growth stalling in the third quarter.”

Meanwhile, in spite of this hint of 'stagflation' from Belgium,  price pressures are said to be easing in Germany and Spain, but the  newest euro-area 'flash inflation' indicator nonetheless remains stubbornly stuck at 3%.

“Inflation in the 17-nation euro area remained at 3 percent for the third consecutive month in November, according to a first estimate, suggesting the European Central Bank may have to consider delaying a further interest rate cut.”

Given that the ECB indeed uses a 'price targeting' policy – as utterly mistaken as that policy is (see our article 'The Errors and Dangers of the Price Stability Policy' for details as to why that is so) – the stubbornly high CPI measurement should in theory keep it from cutting its administered interest rates further. However, as we have pointed out further above, even though CPI remains 'above target', there is now outright monetary deflation in several euro area member nations, while euro-area-wide true money supply has increased by a very small 1.3% over the past year – its lowest annual increase since the introduction of the common currency. In fact, as we have argued many times, it is precisely because monetary inflation has slowed down so much that the crisis has come to the fore. An inflationary system always falls into crisis once the rate of change of monetary inflation slows down.


Euro area CPI (HICP) inflation, short and long term, via – click for better resolution.



Concurrently, EU-wide economic sentiment continues to tumble and has reached a fresh two year low in November.

“Worries about the euro zone's debt crisis worsened in November and dragged the European Commission's economic and consumer sentiment index to a two-year low, heightening the risks of a recession in Europe.

Business managers and consumers turned more pessimistic across almost all sectors of the euro zone's economy and the Commission's monthly economic sentiment index slipped to 93.7, its lowest since late 2009, and down from 94.8 in October. Economists polled by Reuters had expected a figure of 94.0.

Adding to the depth of concern about the debt crisis and a slowing economy shown by last week's purchasing managers' surveys, the Commission's business climate indicator fell for a ninth month. The index slid to -0.44 points from -0.19 and notched up a third month below zero. November's reading was the lowest since February 2010.

"The euro zone's economy seems to be heading into a fairly deep recession," said Jennifer McKeown, an economist at Capital Economics in London.”


A close-up of the EU commission's euro area economic sentiment indicator – click for better resolution.



A 5 year chart of the euro area economic sentiment indicator (up to the October reading, the latest fall is not yet included on this chart) – the trend is pretty obvious by now. Note that sentiment is falling at a steeper trajectory than at the beginning  of the last economic downturn – click for better resolution.



What's a central banker to do when faced with such seemingly contradictory data? Our bet is that the ECB will once again ignore its 'price level targeting' at the upcoming meeting of the board of governors and instead focus on the newest economic reports prepared by its staff, which will no doubt show that the economic situation is growing more dire. The ECB is no doubt fully aware of the immense problems currently faced by the banking system and the implications for future credit expansion as well as the lingering potential for things to go utterly wrong and end with cascading cross-defaults. Hence we expect a plethora of fresh easing measures to be announced, ranging from a rate cut to the extension of the LTRO's to a time period of 36 months. Meanwhile, the plan to let the ECB begin to help with the bailing out of fiscally challenged euro area sovereigns via the IMF detour will continue to be simmering in the background. Given the technical position of European bond yield charts, especially those of Italy, Spain, Portugal and Belgium at the moment, we expect the pressure on the ECB to increase further.


Addendum 1:

The German one year note yield has today fallen below zero for the first time ever, and is trading at a yield of minus 2.9 basis points at the time of writing. This is indicative of the growing mistrust investors harbor vis-a-vis the banking system – they are prepared to pay a premium for keeping money parked in the one year German note rather than to leave it on deposit with the banks.

China meanwhile has embarked on easing measures as well now, with the PBoC announcing a 50 basis points cut in its reserve ratio to 21% after the close of trading in Shanghai today.



Addendum 2:


Just as we were about to wrap up this report, the following announcement was made by the ECB, confirming a prediction we have made about a week ago – namely that the rate at which banks could borrow from the dollar swap line with the Fed would be lowered. In addition, further bilateral swap lines in other currencies than the US dollar have now been established as well:

ECB official statement on US Dollars swap line

Coordinated central bank action to address pressures in global money markets

The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve and the Swiss National Bank are today announcing coordinated actions to enhance their capacity to provide liquidity support to the global financial system. The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.

These central banks have agreed to lower the pricing on the existing temporary US dollar liquidity swap arrangements by 50 basis points so that the new rate will be the US dollar Overnight Index Swap (OIS) rate plus 50 basis points. This pricing will be applied to all operations conducted from 5 December 2011. The authorisation of these swap arrangements has been extended to 1 February 2013. In addition, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank will continue to offer three-month tenders until further notice.

As a contingency measure, these central banks have also agreed to establish temporary bilateral liquidity swap arrangements so that liquidity can be provided in each jurisdiction in any of their currencies should market conditions so warrant. At present, there is no need to offer liquidity in non-domestic currencies other than the US dollar, but the central banks judge it prudent to make the necessary arrangements so that liquidity support operations could be put into place quickly should the need arise. These swap lines are authorised through 1 February 2013.

European Central Bank Decision

The Governing Council of the European Central Bank (ECB) decided in co-operation with other central banks the establishment of a temporary network of reciprocal swap lines. This action will enable the Eurosystem to provide euro to those central banks when required, as well as enabling the Eurosystem to provide liquidity operations, should they be needed, in Japanese yen, sterling, Swiss francs and Canadian dollars (in addition to the existing operations in US dollars).

The ECB will regularly conduct US dollar liquidity-providing operations with a maturity of approximately one week and three months at the new pricing. The schedule for these operations, which will take the form of repurchase operations against eligible collateral and will be carried out as fixed-rate tender procedures with full allotment, will be published today on the ECB’s website.

In addition, the initial margin for three-month US dollar operations will be reduced from currently 20% to 12% and weekly updates of the EUR/USD exchange rate will be introduced in order to carry out margin calls. Those changes will be effective as of the operations to be conducted on 7 December 2011. Further details about the operations will be made available in the respective modified tender procedure via the ECB’s Website.

There was a bit of a reaction to the announcement in the euro basis swaps market – see the below chart of the one month euro basis swap:



The one month euro basis swap briefly spikes up from its recent extreme following the ECB announcement on dollar swap lines – click for better resolution.



3 month and one year euro basis swaps also bounce in the wake of the announcement – click for better resolution.



Of course, this new arrangement mostly means that more banks will now make use of the dollar liquidity window offered by the ECB – by lowering the rate far below the current market rate, the 'stigma' of borrowing dollars from the ECB has been somewhat reduced. The announcement of coordinated central bank intervention regarding the provision of dollar liquidity has certainly produced a big turnaround in the 'risk' markets ahead of the US open. It remains to be seen how long the euphoria lasts, but as we noted yesterday: when so many people are on the same side of the boat – as evidenced by the huge speculative short position in the euro – the markets will soon do the unexpected.


From sentimentrader, an update of the euro futures commitments of traders. As can be seen, the small trader net short position is at a record high, while the overall speculative net short position is at a 17 month high – click for better resolution.




Charts by: Bloomberg,,




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3 Responses to “Euro Area Debt Implosion – A ‘Work In Progress’”

  • roger:

    Here is the assessment of the current situation by Kyle Bass regarding the current situation. He also included his analysis on the possibility of the use of IMF.

    Opinions on his comments on the use of IMF, Pater?

    • First of all, his analysis of the situation is imo entirely correct – it really DOES come down to ‘will they print right away or only after the debt implosion’. However, we already see now what the concrete steps will be that the eurocracy will employ to buy more time: the national central banks of the euro system (which really are all ‘arms of the ECB’ nowadays) will lend to the IMF in ‘bilateral loans’ to stock up the SDR quote of each nation concerned, with the aim of increasing the IMF’s lending capacity. So there WILL be a last ditch attempt to avert the big Kahuna defaults of Spain and Italy.
      Whether that scheme will work is a different cup of tea – I’m with Bass in the sense that I harbor grave doubts.

  • The should rename the special purpose vehicle the “Oops, we screwed up the trade folder”.

    Looking at the Euro COT, it becomes clear one more time you never line up against the group that has the power to rig the trade.

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