Recap 6-4-12

Main Items:

  • EU Said to Prepare Start of Permanent Bailout Fund for July 9
  • Reuters: German Chancellor Angela Merkel is pressing for much more ambitious measures, including a central authority to manage euro area finances, and major new powers for the European Commission, European Parliament and European Court of Justice. She is also seeking a coordinated European approach to reforming labor markets, social security systems and tax policies, German officials say. Until states agree to these steps and the unprecedented loss of sovereignty they involve, the officials say Berlin will refuse to consider other initiatives like joint euro zone bonds or a "banking union" with cross-border deposit guarantees – steps Berlin says could only come in a second wave. The goal is for EU leaders to agree to develop a road map to "fiscal union" at a June 28-29 EU summit. European countries would then put the meat on the bones of the plan in the second half of 2012.
    Germany is pressing Madrid to accept aid under the bloc’s rescue funds so that it can recapitalize its stricken financial institutions, multiple sources have told Reuters. But the Spanish government is resisting, fearful of the stigma attached to a formal state rescue. It is trying to convince its partners to let EU bailout funds bypass the state and funnel aid directly to banks – a step Berlin opposes.
    One ECB source told Reuters the bank had a number of tools at its disposal to tide the bloc over, including cutting interest rates and launching a third round of cheap loans to banks via a so-called Long Term Refinancing Operation (LTRO). It is much less keen to revive its government bond-buying program.
    The French official said … "I think the problem is not so much the European people but the European politicians who don’t want to relinquish their power. There you will see a lot of resistance."
  • New York PMI declined to 49.9 in May vs 61.2 prev


  • EU Sentix Investor Confidence declined to -28.9 in May vs -30 exp
  • EU PPI declined to 2.6% YoY in Apr vs 2.7% exp and 3.3% prev
  • China Non Mfg PMI declined to 55.2 in may vs 56.1 prev

Upcoming Data:

  • Tues: RBA, Italian Service PMI, BoC, ISM Non-Mfg, Australia GDP
  • Wed: UK PMI Construction, EU GDP, ECB, US Unit Labor Costs, Australia Employment
  • Thurs: French Unemployment, Swiss Unemployment, Swiss CPI, UK PMI Services, BoE, US initial jobless Claims, Japan Trade Balance


Some possible market catalysts over the coming weeks:
1) Another Spanish bank needs a bailout.
2) Spain agrees to take ESM money and uses it to recapitalize its banking system. Based on broker estimates, it will need at least 30bn. A credible recap will probably need to exceed 100bn. (JPM estimates 150bn)
3) ESM begins purchasing Spanish bonds once it is activated.
4) ECB initiates another LTRO & potentially also reduces Refi rates & collateral haircuts.
5) Fed eases further by purchasing MBS. Bernanke speaks on Thurs
6) Greece continues to miss austerity targets (ok, this one is guaranteed)

The bank recap is probably the most important. Another LTRO will probably be of only limited help to the weaker Spanish banks because they are already heavily levered after the bank run. 1Q balance sheets show tangible equity for the non-international Spanish banks is just 5% or less of assets, while the ECB requires margin of at least 4% for government debt with maturities > 7 years. Germany will probably continue insisting that the recap goes through the Spanish government first, since the ESM itself does not have supervisory powers over Spanish banks. This means that the recap will be dependent upon the Spanish government capitulating and asking for ESM assistance, and accepting oversight. That will probably be preceded by 10y Spanish bond yields breaking above 7% and another Spanish bank bailout request.

Some market participants argue that a recap alone is insufficient because from 2012-2014, Spain will run a deficit of 121bn, and faces 228bn of maturities, while Italy will have a cumulative deficit of 94bn and faces 575bn of maturities. But that view discounts the fact that EU banks will be coerced into rolling and even increasing their sovereign debt holdings if balance sheets allow. Given the declining percentage of Spanish and Italian debt that is owned by foreigners, (~30%, with a wide margin of error) it’s more likely that actual additional funding needs are ~200bn and ~285bn, respectively. One optimistic view is that EU banks will be able to use recapitalization money and/or earnings, lever up 10x using ECB LTRO’s, and supply their government’s net funding needs. In other words, a recapitalization will not solve the problems in the EU, but it could be more effective and buy more time than expected.

Separately, Soros suggests in a speech on Sat that Merkel has 3 months to save the EU:
“In my judgment the authorities have a three months’ window during which they could still correct their mistakes and reverse the current trends. By the authorities I mean mainly the German government and the Bundesbank because in a crisis the creditors are in the driver’s seat and nothing can be done without German support.
I expect that the Greek public will be sufficiently frightened by the prospect of expulsion from the European Union that it will give a narrow majority of seats to a coalition that is ready to abide by the current agreement. But no government can meet the conditions so that the Greek crisis is liable to come to a climax in the fall. By that time the German economy will also be weakening so that Chancellor Merkel will find it even more difficult than today to persuade the German public to accept any additional European responsibilities. That is what creates a three months’ window.”