Yesterday, we were struck by the increasing convergence of the views of various market observers as to the outcome of the ongoing crisis. It seems now widely accepted as almost a fait accompli that the euro will disintegrate within weeks. Even Jim Cramer (euro bears please take note…) is now on 'Defcon 3', predicting imminent 'financial collapse'. The Economist writes 'Unless Germany and the ECB act quickly, the single currency's collapse is looming'.
"Germany’s cautious chancellor, Angela Merkel, can be ruthlessly efficient in politics: witness the way she helped to pull the rug from under Silvio Berlusconi. A credit crunch is harder to manipulate. Along with leaders of other creditor countries, she refuses to acknowledge the extent of the markets’ panic (see article). The European Central Bank (ECB) rejects the idea of acting as a lender of last resort to embattled, but solvent, governments. The fear of creating moral hazard, under which the offer of help eases the pressure on debtor countries to embrace reform, is seemingly enough to stop all rescue plans in their tracks. Yet that only reinforces investors’ nervousness about all euro-zone bonds, even Germany’s, and makes an eventual collapse of the currency more likely.
This cannot go on for much longer. Without a dramatic change of heart by the ECB and by European leaders, the single currency could break up within weeks. Any number of events, from the failure of a big bank to the collapse of a government to more dud bond auctions, could cause its demise. In the last week of January, Italy must refinance more than €30 billion ($40 billion) of bonds. If the markets balk, and the ECB refuses to blink, the world’s third-biggest sovereign borrower could be pushed into default.“
(emphasis added)
We certainly agree that Mrs. Merkel is possibly underestimating the speed and ferocity at which a market panic could crush her ambitious integration plans. We also agree that there are a number of potential events that could become the triggers for such a panic. There is considerable risk that in the case of the failure of a big bank, a wave of cascading cross-defaults could engulf the system. As noted before, Italy and Spain are unlikely to be able to refinance their debts in the markets for very long with bond yields at 7% or higher. To be more precise, they may well be able to roll over their debt at such yields, but sooner or later market access would close down due to the arithmetic of the debt spiral these high yields would inexorably produce.
Spain's debt rollovers from August 2011 onward – click for better resolution.
Meanwhile, the Telegraph reports that the UK Foreign Office is drawing up plans to help British expatriates as it 'warns of riots in the event of a euro collapse'.
"Diplomats are preparing to help Britons abroad through a banking collapse and even riots arising from the debt crisis.
The Treasury confirmed earlier this month that contingency planning for a collapse is now under way. A senior minister has now revealed the extent of the Government’s concern, saying that Britain is now planning on the basis that a euro collapse is now just a matter of time.
"It’s in our interests that they keep playing for time because that gives us more time to prepare,” the minister told the Daily Telegraph.
Recent Foreign and Commonwealth Office instructions to embassies and consulates request contingency planning for extreme scenarios including rioting and social unrest. Greece has seen several outbreaks of civil disorder as its government struggles with its huge debts. British officials think similar scenes cannot be ruled out in other nations if the euro collapses.
Diplomats have also been told to prepare to help tens of thousands of British citizens in eurozone countries with the consequences of a financial collapse that would leave them unable to access bank accounts or even withdraw cash.“
We are actually suspecting that the 'Telegraph' took what is a quite routine contingency planning exercise (after all, the bureaucrats need something to while away their time with) and fabricated a sensationalistic headline out of it. What makes it interesting to us is mainly the fact that the article has been published at all. Poland's foreign minister Radoslav Sikorski meanwhile delivered an impassioned plea to Germany to 'act to save the euro' in a speech held near the Brandenburg Gate in Berlin.
"Germany is the only country in Europe that can act to save the eurozone and the wider European Union from “a crisis of apocalyptic proportions”, the Polish foreign minister warned on Monday in a passionate call for more drastic action to prevent the collapse of the European monetary union.
The extraordinary appeal by Radoslaw Sikorski, delivered in the shadow of the Brandenburg Gate in the German capital, came as the Organisation for Economic Co-operation and Development called on European leaders to provide “credible and large enough firepower” to halt the sell-off in the eurozone sovereign debt market, or risk a severe recession.“
[...]
In a startling comment for a senior Polish minister, Mr Sikorski declared that the biggest threat to his nation’s security was not terrorism, or German tanks, or even Russian missiles, but “the collapse of the eurozone”.
There it is again – apocalypse!
Meanwhile, speculators have certainly joined the bandwagon, increasing their net short position in euro futures to yet another 17 month high, with their exposure rising another 11% last week alone.
Considering all these panicked invocations of imminent collapse one is left to wonder though, why did the DJIA rise by nearly 300 points yesterday? If we are not completely mistaken about the meaning of positioning data, then we would argue that with virtually everyone already sitting on the same side of the boat, the markets will begin to do the unexpected – which in this case means the euro should at least see some short term strength, which in turn would have affect many other markets due to the well-known and well-worn inter-market correlations that the systematic black boxes and robots trade off.
