More on Sovereign Debt Crises

By: Doug Noland | Fri, Jul 22, 2011
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For the week, the S&P500 jumped 2.2% (up 6.9% y-t-d), and the Dow gained 1.6% (up 9.5%). The Banks rallied 3.3% (down 8.4%), and the Broker/Dealers surged 6.6% (down 10.1%). The Morgan Stanley Cyclicals inched up 0.2% (up 2.8%), and the Transports rose 1.6% (up 6.3%). The Morgan Stanley Consumer index was little changed (up 2.0%), while the Utilities gained 1.5% (up 7.3%). The S&P 400 Mid-Caps increased 1.6% (up 9.3%), and the small cap Russell 2000 gained 1.6% (up 7.4%). The Nasdaq100 jumped 3.1% (up 9.5%), and the Morgan Stanley High Tech index rose 2.0% (down 0.2%). The Semiconductors surged 4.7% (down 0.8%). The InteractiveWeek Internet index gained 1.7% (up 3.4%). The Biotechs increased 1.4% (up 12.2%). With bullion increasing $8, the HUI gold index rose 1.8% (up 0.9%).

One-month Treasury bill rates ended the week at 3 bps and three-month bills closed at 3 bps. Two-year government yields rose 3 bps to 0.39%. Five-year T-note yields ended the week up 7 bps to 1.51%. Ten-year yields rose 6 bps to 2.97%. Long bond yields added a basis point to 4.26%. Benchmark Fannie MBS yields increased 4 bps to 3.93%. The spread between 10-year Treasury yields and benchmark MBS yields narrowed 2 to 96 bps. Agency 10-yr debt spreads declined 3 bps to negative 10 bps. The implied yield on December 2012 eurodollar futures declined one basis point to 0.83%. The 10-year dollar swap spread declined 4 to 10 bps. The 30-year swap spread was little changed at negative 33.75 bps. Corporate bond spreads narrowed. An index of investment grade bond risk declined 4 bps to 93 bps. An index of junk bond risk dropped 27 bps to 463 bps.

Debt issuance picked up. Investment-grade issuers included Goldman Sachs $2.75bn, IBM $2.0bn, Morgan Stanley $2.0bn, Bank of New York Mellon $1.6bn, PNC Financial $1.0bn, Braskem America $500 million.

Junk bond funds saw inflows decline to $287bn (from Lipper). Junk issuers included MTR Gaming $565 million, Suncoke Energy $400 million and North Atlantic Trading $285 million.

Convertible debt issuers included Micron Technology $600 million, Endeavour International $135 million, Powerwave Technologies $100 million and Horsehead Holding $80 million.

International dollar bond issuers included National Australia Bank $2.6bn, Toronto Dominion Bank $2.5bn, Sumitomo Mitsui $2.0bn, Dominican Republic $1.25bn, Sri Lanka $1.0bn, Petroleos Mexicanos $1.0bn, Korea Housing Finance $500 million, JSC Severstal $500 million, and Banco Industrial $150 million.

A remarkable week in the European bond market. German bund yields jumped 13 bps to 2.83% (down 13bps y-t-d), and U.K. 10-year gilt yields rose 3 bps this week to 3.11% (down 40bps). Greek two-year yields ended the week down 536 bps to 26.28% (up 1,405bps). Greek 10-year note yields sank 286 bps to 14.20% (up 174bps). Italian 10-yr yields dropped 36 bps to 5.39% (up 58bps), and Spain's 10-year yields fell 31 bps to 5.74% (up 30bps). Ten-year Portuguese yields dropped 172 bps to 10.50% (up 392bps). Irish yields fell 211 bps to 11.63% (up 258bps). The German DAX equities index rallied 1.5% (up 6.0% y-t-d). Japanese 10-year "JGB" yields added one basis point to 1.10% (down 2bps). Japan's Nikkei gained 1.6% (down 0.9%). Emerging markets were mostly higher. For the week, Brazil's Bovespa equities index rallied 1.3% (down 13.0%), while Mexico's Bolsa declined 1.1% (down 7.3%). South Korea's Kospi index gained 1.2% (up 5.9%). India's equities index increased 0.9% (down 8.7%). China's Shanghai Exchange fell 1.8% (down 1.3%). Brazil's benchmark dollar bond yields declined 8 bps to 3.95%, and Mexico's benchmark bond yields fell 8 bps to 3.88%.

Freddie Mac 30-year fixed mortgage rates added one basis point to 4.52% (down 4bps y-o-y). Fifteen-year fixed rates increased a basis point to 3.66% (down 37bps y-o-y). One-year ARMs gained 2 bps to 2.97% (down 73bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 6 bps to 4.99% (down 45bps y-o-y).

Federal Reserve Credit declined $4.2bn to $2.855 TN (37-wk gain of $574bn). Fed Credit was up $447bn y-t-d and $539bn from a year ago, or 23%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 7/20) increased $3.2bn to $3.454 TN. "Custody holdings" were up $104bn y-t-d and $322bn from a year ago, or 10.3%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $1.616 TN y-o-y, or 19.1% to $10.058 TN. Over two years, reserves were $3.055 TN higher, for 44% growth.

M2 (narrow) "money" supply increased $6.5bn to a record $9.259 TN. "Narrow money" has expanded at a 8.9% pace y-t-d and 7.6% over the past year. For the week, Currency increased $1.3bn. Demand and Checkable Deposits dropped $25.4bn, while Savings Deposits jumped $34.3bn (6-wk gain of $206bn). Small Denominated Deposits declined $3.3bn. Retail Money Funds fell $3.7bn.

Total Money Fund assets dropped $24.75bn last week to $2.672 TN. Money Fund assets were down $114bn y-t-d, with a decline of $126bn over the past year, or 4.5%.

Total Commercial Paper outstanding declined $24.4bn to $1.208 Trillion. CP was up $239bn y-t-d, or 37% annualized, with a one-year rise of $108bn.

Global Credit Market Watch:

July 19 - Bloomberg (Simon Kennedy): "Euro-area leaders fanned out to persuade investors that last night's array of crisis-fighting measures can help stop the debt turmoil that's defied them for more than a year. German Chancellor Angela Merkel said government chiefs had learned from the "systemic effects" in the single-currency area and widened the scope of their bailout fund to allow it to buy the bonds of debt-laden nations, support banks and offer credit lines. The agreement included new aid for Greece that embraced bondholders, prompting Fitch Ratings to say it will put a default rating on Greek debt. The risk is that the package will follow the pattern of previous agreements and eventually disappoint markets. Leaders declined to increase the 440 billion euro ($632bn) fund, prompting economists from Citigroup Inc. to Goldman Sachs Group Inc. to question whether it's big enough to insulate Spain and Italy from contagion."

July 20 - Market News International: "Greece must leave the Eurozone should it restructure its debt, former European Central Bank chief economist Otmar Issing told German daily Frankfurter Allgemeine Zeitung... 'It would herald the end of the currency union should Greece be able to stay in the currency union [after restructuring] and trust in more support and ECB refinancing,' Issing said. Issing warned that allowing a default within the Eurozone would take all pressure off Greece to implement reforms and other Eurozone member states would soon be keen to follow Greece's easy way out of excessive debt. Issing also said that the introduction of Eurobonds are not the right approach out of the crisis. 'Politicians who want to save the currency union with such measures will turn out to be the gravediggers of a stable euro,' he said."

July 20 - Bloomberg (Ben Martin): "Junk corporate bonds are turning into a losing bet in Europe as surging sovereign yields infect assets that just 18 months ago were handing investors returns of more than 75%. Speculative-grade bonds have lost 1.1% on average this month, adding to the 1.6% investors forfeited in June... 'There's so much uncertainty about the future of the euro project,' said Marchel Alexandrovich... economist at Jefferies International... 'No one knows what tomorrow will bring.'

July 19 - Dow Jones (Prabha Natarajan): "U.S. companies have taken out almost $1 trillion of syndicated loans so far this year, an 82% increase from 2010 levels and a return to levels last seen before the crisis. Borrowers are turning to the loan market because that is where investors are migrating, attracted by floating rates, which will rise when interest rates go up; the security of collateral; and a higher position in the capital structure, meaning loans are repaid before bonds if the borrower runs into trouble... 'Banks are stepping out on the risk spectrum and lending money.'"

July 20 - Bloomberg (Christine Idzelis and Patricia Kuo): "Loans backing buyouts by Apax Partners LLP and Polish billionaire Zygmunt Solorz-Zak are poised to push issuance past 2010 levels as signs emerge that demand for the debt is waning... Banks have underwritten $28.4 billion for U.S. buyouts this year and are marketing $13 billion, compared with 2010's total of $30.4 billion... 'The market looks potentially catastrophic but I think people will work it out, it's just that there will be a lot of bumps along the way,' said Fergus Elder, who runs global loans and capital markets Europe at Australia & New Zealand Banking Group... The average price for high-yield, high- risk loans in Europe was 89.73% of face value at the end of last week, the lowest this year..."

July 19 - Bloomberg (Katrina Nicholas): "Borrowing costs have risen to record levels for Chinese companies marked with 'red flags' by ratings firms for unclear financial reporting and high levels of private ownership... The bookkeeping of Chinese corporations has come under scrutiny after short sellers said companies from Longtop Financial Technologies Ltd. to Sino-Forest Corp. were overstating profit margins or exaggerating asset holdings."

Global Bubble Watch:

July 21 - Bloomberg (John Detrixhe): "Standard & Poor's reiterated that the U.S. may lose its AAA credit rating as soon as August as the risk of a default escalates amid political wrangling to lift the debt limit while cutting the budget deficit. The rating may be lowered to the AA+/A-1+ range with a negative outlook next month even if an agreement to raise the debt ceiling in time to avert a potential default without a 'credible' plan to lower deficits, S&P said..."

July 22 - Bloomberg (Abigail Moses): "The International Swaps & Derivatives Association said participation of private bondholders in the Greek rescue plan 'should not trigger credit-default swaps' on the nation because it's 'expressly voluntary'... ISDA's determinations committee makes binding decisions for the market on whether credit swaps can be triggered. A credit event can be caused by a reduction in principal or interest, postponement or deferral of payments or a change in the ranking or currency of obligations, according to the New York-based trade group's rules."

July 19 - Bloomberg (Gavin Finch, Elisa Martinuzzi and Charles Penty): "European banks may have to raise as much as 80 billion euros ($112bn) of additional capital as the stress tests failed to allay investor concern about a Greek default and governments' ability to bail out their lenders."

July 22 - Telegraph: "The €159bn Greek bailout is bad news for German taxpayers, the country's influential Ifo think tank said... Hans-Werner Sinn, the head of the think tank and an open critic of the bailout, said: 'Germany and France should not make policies that lead to the collectivisation of debts in Europe.' He told Reuters TV: "The financial markets are reacting very positively to yesterday's agreements. As this is a conflict of apportionment between Europe's tax payers and investors, this is bad news for tax payers."

Currency Watch:

The U.S. dollar index fell 1.2% this week to 74.245 (down 6.1% y-t-d). For the week on the upside, the the Norwegian krone increased 2.6%, the Swedish krona 2.5%, the New Zealand dollar 2.3%, the Australian dollar 1.9%, the South African rand 1.6%, the Danish krone 1.5%, the Brazilian real 1.5%, the euro 1.4%, the British pound 1.0%, the Mexican peso 0.9%, the Singapore dollar 0.9%, the Japanese yen 0.8%, the South Korean won 0.6%, and the Canadian dollar 0.6%. On the downside, the Swiss franc declined 0.5%.

Commodities and Food Watch:

The CRB index increased 0.5% (up 4.5% y-t-d). The Goldman Sachs Commodities Index gained 1.1% (up 11%). Spot Gold added 0.5% to $1,601 (up 12.7%). Silver jumped 2.7% to $40.12 (up 30%). September Crude gained $2.27 to $99.87 (up 9%). August Gasoline was little changed (up 28%), while August Natural Gas fell 3.2% (unchanged). September Copper was little changed (down 1%). September Wheat dipped 0.4% (down 13%), and September Corn declined 1.6% (up 10%).

China Bubble Watch:

July 19 - Bloomberg: "China's tax revenue rose 29.6% to 5 trillion yuan ($773 billion) in the first half of the year, giving officials more room to maneuver as they grapple with swelling local-government debt... 'Stable' economic growth and rising company profits helped to bolster revenue, with inflation also playing a role, the ministry said. The fiscal strength that encouraged Standard & Poor's to raise China's debt rating in December may help the nation to absorb any fallout from banks' loans going bad after stimulus spending that began in 2008."

July 21 - Bloomberg: "China's manufacturing may contract for the first time in a year as output and new orders drop, preliminary data for a purchasing managers' index indicated. The gauge fell to 48.9 for July from a final reading of 50.1 for June..."

India Watch:

July 20 - Bloomberg (Kartik Goyal and Unni Krishnan): "India will stick to its borrowing plan even as short-term yields on government debt are 'unnecessarily high,' said R. Gopalan, the top official in the finance ministry's economic affairs department. 'My net borrowings for the fiscal year will remain the same; I don't think it will go beyond that... We have discretion to say what can be the tenures which we access the market. We don't want to surprise the markets on the scheduled calendar.' ...Finance Minister Pranab Mukherjee aims to trim the budget deficit to a four-year low of 4.6% in the year ending March 31..."

July 20 - Bloomberg (Unni Krishnan and Kartik Goyal): "India is considering a plan to set aside $10 billion from its foreign-exchange reserves and create a sovereign wealth fund to secure energy assets overseas, an aide to Prime Minister Manmohan Singh said."

July 21 - Bloomberg (Rajesh Kumar Singh, Anurag Joshi and Archana Chaudhary): "Nuclear Power Corp. of India plans to borrow as much as 4 billion euros ($5.7bn) from European banks to build the world's largest atomic power plant... The loan will be guaranteed by French trade-credit insurer Coface SA."

Asia Bubble Watch:

July 20 - Bloomberg (Shamim Adam): "Asian cuisine may be too much of a good thing for some of the region's central banks as policy makers grapple with the challenge of responding to spikes in the cost of staples from rice and pork to onions and chilies. Pork prices jumped 57% in June in China... Rice, the staple food for more than half of the world population, has surged about 70% in the past year. A wider variety of diet and greater purchasing power for non-food items leave wealthier nations less vulnerable to food-cost spikes. Food makes up more than 30% of inflation indexes on average in Asia, compared with about 15% in Europe and less than 10% in the U.S., according to Rabobank Groep NV."

Latin America:

July 21 - Bloomberg (Camila Russo): "Argentina's benchmark deposit rate jumped to its highest in almost two years as banks seek funds to meet surging loan demand at a time when investors are pulling money out of South America's second-largest economy. The average interest banks pay on 30-day deposits of more than 1 million pesos ($242,884)... was 11.4% over the past 15 days, the highest in 21 months."

Unbalanced Global Economy Watch:

July 20 - Bloomberg (Rainer Buergin): "Germans became more pessimistic last week as concerns about the stability of the euro grew, Stern magazine said... 'Many, especially older people, worry about their hard- earned savings,' Stern cited Forsa head Manfred Guellner as saying. "For them, the German mark was still a guarantor of stability.'"

July 20 - Bloomberg (Frances Schwartzkopff): "Mortgage lending in Denmark, the world's third-largest mortgage bond market, slumped 8% in the second quarter to its lowest level in four years, hampering the Nordic country's economic recovery."

July 21 - Bloomberg (Steve Bryant and Maria Petrakis): "The boom that turned Turkey into Europe's fastest-growing economy may be imperiled by the debt crisis in neighboring Greece... Prime Minister Recep Tayyip Erdogan hailed Turkey's 11% first-quarter expansion as 'magnificent' on June 30. It hasn't prevented the lira from sliding to a two-year low, as the country's trade deficit widens on surging demand for imports."

U.S. Bubble Economy Watch:

July 21 - Bloomberg (Anna-Louise Jackson and Anthony Feld): "Consumers in the U.S. are increasingly using credit cards to pay for basic necessities as income gains fail to keep pace with rising food and fuel prices. The dollar volume of purchases charged grew 10.7% in June from a year ago, while the number of transactions rose 6.8%, according to... SpendTrend report... The difference probably represents the increasing cost of gasoline, said Silvio Tavares, senior vice president at First Data... 'Consumers, particularly in the lower-income end, are being forced to use their credit cards for everyday spending like gas and food... That's because there's been no other positive catalyst, like an increase in wages, to offset higher prices. It's a cash-flow problem.'"

Real Estate Watch:

July 21 - Bloomberg (Oshrat Carmiel and Ashwin Seshagiri): "Home prices in New York's Hamptons, the Long Island resort towns favored by summering Manhattanites, increased 4.2% in the second quarter from a year earlier as buyers opted for more expensive beach properties. The median price of homes that sold in the quarter rose to $937,500... according to... Miller Samuel Inc. and broker Prudential Douglas Elliman Real Estate. Thirty-nine percent of all sales completed in the Hamptons and Long Island's North Fork were for houses priced at $1 million or more, the second-highest market share for such properties in three years."

July 21 - Bloomberg (Kathleen M. Howley): "U.S. home prices fell 6.3% in May from a year earlier as foreclosures weighed down values and purchases slumped. The decline was led by a 9.9% decrease in the region that includes California, the Federal Housing Finance Agency said today in a report from Washington. The second-largest drop was 9.2% in the area that includes Nevada and Arizona."

July 20 - Bloomberg (Brian Louis): "U.S. commercial property prices increased in May for the first time in six months as a rebound in distressed real estate helped boost values, according to Moody's... The Moody's/REAL Commercial Property Price Index rose 6.3% from April... It's down 11% from a year earlier and 46% below the peak of October 2007..."

Muni Watch:

July 19 - Bloomberg (James Nash and William Selway): "Five of the 15 states with top bond ratings from Moody's... may be downgraded because their dependence on federal revenue makes them vulnerable to a U.S. credit cut should talks to raise the debt limit fail. Maryland, South Carolina, New Mexico, Tennessee and Virginia are under review...Moody's said... The action affects $24 billion of general-obligation and related debt... The states are rated Aaa, Moody's top municipal grade."

July 19 - Bloomberg (Andrew Zajac): "Federal legislation to simplify a hodge-podge of state tax laws would give businesses a multi-billion dollar tax break and further strain state and local government budgets, according to state government officials... 'You're taking existing revenue away from states at a time when they're trying to recover,' David Quam, director of federal relations for the National Governors Association, told Bloomberg..."

California Watch:

July 21 - Bloomberg (Sarah Frier and Christopher Palmeri): "Los Angeles, which is selling $380 million in debt today, may benefit from demand for California bonds with long-term issuance at the lowest since 2000. Issuers in the state sold less than $13 billion in bonds from Jan. 1 through yesterday, compared with $27 billion in the same period in 2008... California... hasn't sold any general-obligation bonds in 2011 as legislators debated solutions for a $26 billion deficit."


More on Sovereign Debt Crises

I'll continue to devote considerable analytical attention to the unfolding European debt crisis. These debt markets are in the midst of a problematic crisis of confidence, in a marketplace that again elicited an aggressive policy response. Here at home, and despite obvious risks and politicians content to play with fire, the market is more than fine with Treasurys. The thesis remains that the sovereign debt crisis that erupted in Greece - and moved to consume Ireland and Portugal before arriving at the door of Spain and Italy - will eventually engulf our government debt market as well.

As I attempted to explain last week, sovereign debt crises have important differences to those impacting private-sector Credit instruments. For one, sovereign debt problems tend to manifest subsequent to major private debt boom and bust cycles. They will follow serious expansions in both public sector debt and the government's assumption of private-sector risks and obligations. And, sovereign debt crisis will likely develop as the markets begin questioning the future efficacy of fiscal and monetary policy measures, stimulus employed with increasing fervor to battle persistent private sector debt and economic woes.

It is the nature of sovereign crises to unfold during a period of economic fragility and general market aversion to private sector debt. In such a backdrop, government Credit growth will likely comprise a large - and critical - part of total system Credit expansion. So the system overall - the real economy and the financial sphere - finds itself extraordinarily susceptible to any waning of market demand for government Credit. Or, stated differently, the stakes involved in a crisis of confidence in sovereign debt are extremely high - and we should fully expect policymakers to respond accordingly. Both the public's and markets' expectations for policymaking will be at inflated - and susceptible - levels. Inevitably, confidence game dynamics will hold sway, with policy makers increasingly held hostage to the demands of the markets.

After seeing the marketplace challenge their "manhood," European ministers resorted to some "shock and awe" for the latest Greek debt summit. At $229bn, the outright cost of the second round of Greek support surpassed what was thought to be a one-time bailout from a year ago. Private bond holders will have to pony up somewhat this time, through four options including extending the debt maturities into long-term bonds. Maturities on Greek borrowings from the European Financial Stability Facility (EFSF) will be doubled to 15 years, while interest rates will be dropped to between 3.5% and 4.0% (terms loosened as well for Ireland and Portugal). Overall, the Greek debt load will be reduced only marginally. In no way have two enormous bailouts meaningfully ameliorated Greece's solvency issue.

Debt crisis has been a regular part of economic life for centuries. Scores of books have been written and, over generations, some analytical consistency emerged as to how best to manage these types of crises. A key focus is to determine if the nucleus of the crisis is one of "liquidity" or more an issue of "solvency". In simple terms, is it a case of a responsible borrower with a manageable debt load facing a short-term inability to obtain necessary finance and/or roll-over maturing debt? Or, instead, is the marketplace dealing with a borrower hopelessly buried in unmanageable debt that is destined to be a further drain on limited resources (not to mention moral hazard issues)?

Centuries of experience are rather clear on the issue. There are benefits to both the borrower and the system when a solvent borrower facing liquidity issues receives access to a temporary funding mechanism - although this stressed borrower must provide sound collateral and borrow only at punitive rates (to dis-incentivize excess risk-taking and market reliance on liquidity backstop mechanisms). And it is equally important to push insolvent borrowers into debt restructuring. Incentives and rules of the game are critical to protect the integrity of system Credit as well as monetary management. Insolvency is a cancer (think S&Ls from the '80s or, more recently, Fannie/Freddie).

Still, extending life support to the insolvent is a recurring theme of financial history, and it is fascinating to see it as a recurring theme of how relatively small crises evolve over time into major systemic crises of confidence. It is a mistake made again and again - a seminal Lesson Repeatedly Left Unlearnt. Why? Because, of course, it's seemingly always politically expedient to bail out troubled borrowers rather than to deal with the messy short-term consequences of pulling the plug. Especially when it comes to a systemically important financial institution (and certainly sovereign borrowers), policymakers view the costs and risks (including "contagion" effects) sufficient to try the support, bailout and hope method. And the more fragile things appear, the greater the inclination to help things along with added government debt and loose "money".

"Throwing good money after bad" is one of economic policymaking's great cardinal sins. If somehow systems could only rid themselves of "rotten apples" before it's too late. But especially in our complex world, one can line up experts on virtually any issue and come to diametrically opposed conclusions. Objectively, Greece is hopelessly insolvent. European policy focus should have by now shifted away from a short-term fixation on the periphery to a more strategic focus of ensuring stability at the core. Instead, the market's obsession with the short-term again dominated the policy debate, and a much grander second bailout package was viewed as the ONLY solution to counter escalating contagion.

Defying the lessons of history, Greece was granted a slug of additional "money" at extremely favorable borrowing costs. And European ministers were adamant that Greece is a special case and others will not see similar special treatment. Right. Financial history is strewn with broken promises of no more bailouts and no more money printing.

The marketplace certainly celebrated the expansion of the EFSF mandate. Germany's influential Der Spiegel publication went with the headline, "Sarkozy Gets His European Monetary Fund." The EFSF will be given the power to act "preemptively" (i.e. Credit lines to Spain and Italy, and their banks, insurers and such, as needed), while also having the mandate to support bond markets through purchases (or expectations of buying) in the secondary markets. Market players have fretted the lack of a reliable market liquidity backstop mechanism. Der Spiegel quoted European Commission President Jose Manuel Barroso: "For the first time since the beginning of this crisis, we can say that the politics and the markets are coming together."

Well, we've not heard the last of the politics of this issue. A Financial Times headline: "Europe's taxpayers face billion-euro cost of private sector clause to fresh Greek bailout." Enlarging the size of the EFSF will have to be taken up by parliaments in Germany, the Netherlands, Finland and throughout the eurozone (the new mandate lacks credibility if EFSF lending power is not expanded). This afternoon from Der Spiegel: "A New Epoch Has Begun in the History of the Euro." From the UK Telegraph: "German Think Tank Ifo Says Greek Bailout Is Bad News for Taxpayers." And from Dow Jones: "Bundesbank Warns Greek Bailout Deal Poses Risk of Moral Hazard."

Today from Bundesbank President, and ECB council member, Jens Weidmann: "By transferring sizeable additional risks to aid-granting countries and their taxpayers, the euro area made a large step toward a collectivization of risks in case of unsolid public finances and economic mistakes. That's weakening the foundations of a monetary union founded on fiscal self-responsibility. In the future, it will be even more difficult to maintain incentives for solid fiscal policies."

It is central to the "global government finance Bubble" thesis that enormous international sovereign debt issuance, unprecedented central bank monetization, and ongoing activist policymaking ("inflationism") continue to distort risk perceptions and market pricing throughout risk asset marketplaces across the globe. And the greater the perceived risks to various global Bubbles (European debt or Treasurys, for example) the greater the degree of market confidence that policymakers will act faithfully to address issues - and bolster the markets! Evidence of the enormity of this Bubble (along with the accumulation of risk by U.S. and "core" European sovereign borrowers) mounts by the week.

Yesterday's Greek summit certainly emboldens those holding the view that it is best these days to simply ignore risk and ride the policy-induced market wave. It's possible that highly speculative global markets become even more so - and only more volatile, unpredictable and dysfunctional. Certainly, there is the thought that the latest bailout at least buys a few months respite from contagion effects. Perhaps. There was, however, nothing in the new package that lessens debt loads in, say, Spain or Italy - or improves impaired economic structures. Over the past few weeks these types of fundamental factors became key market focal points. Fragilities were illuminated.

After dropping to 5.15% in early trading, Italian 10-year yields ended the day 6 bps higher to 5.39% (down from recent highs but up 60bps in the past month). And I certainly don't expect the Credit default swap marketplace to return to business as usual anytime soon. So, between politics, economic fundamentals and some important marketplace degradation, these speculative and unsettled markets retain an abundance of uncertainty to grapple with.

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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