Wake Up, European Bond Auctions Will Start To Fail, How Much Evidence Do Investors Need?

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Markets keep on trading on “uplifting” headlines instead of digesting the grim fundamentals setting the markets up for a huge fall.

U.S. stocks closed sharply higher up 291 points on Monday as investors reacted to a report that a record number of shoppers turned out for Black Friday, the traditional start of the Christmas shopping season. Shops pulled $52.4bn over the four-day period that starts on Thanksgiving, up 16.7% from last year, according to figures from the National Retail Foundation. Though what we thought was the most surprising was that no financial commentators where asking the question how the Thanksgiving sales were financed considering the overwhelming debt we are facing.

In Europe, various reports pointed to a fresh bout of efforts by policymakers to stem Europe’s sovereign debt crisis. The Wall Street Journal reported leaders are moving closer to a fiscal union, which many analysts say is key to preventing euro-zone members from running up unsustainable debt levels. Though a lot people don’t seem to understand how long it will take to get all European states to agree next to that it is no solution for the unsolvable debt problems we are facing. Speculation flourished on other possible moves to keep the euro zone from falling apart, a dramatic outcome that has appeared more likely as investors have dumped Italian, Greek, French and Belgium debt. Though the International Monetary Fund denied a report in an Italian newspaper that it was considering a €600 billion ($801 billion) credit line for Italy. Also a story in a German newspaper reporting that Germany was considering issuing a joint bond with other triple-A rated European countries; the German finance ministry denied the report. The market is rife with speculation hence the incredible volatility in the markets we are facing.

Downgrades and rising interest rates are the last step before default

S&P downgrades Belgium’s credit rating from AA+ to AA on Friday November 25 following 10-y bonds rising 100 basis points (1%) over one week from 4.8% to 5.8%. Standard & Poor’s downgraded Belgium’s credit rating to AA from AA-plus on Friday, saying funding and market risk pressures are raising the chances the country’s financial sector will need more support. S&P said difficulties in the country’s banking system and the government’s inability to respond to economic pressures contributed to the downgrade. Belgium’s government debt position has worsened in recent months, particularly after it bought the Belgian arm of failing French-Belgian bank Dexia (DEXI.BR) earlier this year.

Moody’s downgraded Hungary’s sovereign debt to junk status, as was Portugal, because its uncertainty to meet its debt reduction goals and its dependence on foreign investors. The IMF warned about Japan’s ballooning budget deficit. Following bond auctions in Spain and Italy interest rates are jumping to unsustainable levels. Italian six month paper was auctioned on Friday for 6.5% up from 3.5% a month ago. The €8bn auction produced a yield of 6.504%, up from around 3.52% in October, according to Bloomberg. Demand weakened, with the total bids exceeding supply 1.47 times, down from a bid-to-cover ratio of 1.57 in October. 3-y paper was peaking at a yield of 8.13%!!

By comparison, Spain paid 5.2 percent to sell six-month paper at a much smaller short-term auction earlier last week, 10-y bonds were selling at 6.67%, after elections handed power to an austerity-committed conservative government. Though even Germany had problems raising €3.9bn, whilst targeting €6bn, with interest rates rising showing the biggest weekly jump for 34 months as German bonds were sucked into the Euro zone’s crisis. It is all Iceland and Greece revisited. It all is just a matter of time before we have the defaults at our hands. As we said in the first blog article we published the authorities are trying to plug one hole while at the same time creating other holes.

Record high yields threaten Rome’s planned gross issuance of €440bn for 2012 as interest payments on the country’s €1.9trn debt pile rise. Analysts say that, at current yield levels, the euro zone third-largest economy risks losing market access as redemptions totaling a massive €150bn for the February-April period approach. Traders said the ECB was buying Italian and Spanish bonds in an attempt to shore the market up. But given its reluctance to prop up high-debt euro zone governments, its bond-buying program has been conducted intermittently and so far not powerfully enough to provide more than short-term stability. New Bank of Italy Governor Ignazio Visco sums it up saying that short-term measures to tame Italy’s budget deficit would not be enough to solve the country’s economic problems and only structural reforms will generate growth. Markets are looking for quick and effective responses from European policymakers, such as a greater involvement of the European Central Bank.

The Eurodollar rates, the cost of swapping three-month Euro funds into dollars, rose to their highest levels since 2008 showing the increasing uncertainty in the system hence also the sharp drop in the US$/€ exchange rate last week from 1.36 to 1.32. We are witnessing a clear flight for safety towards the US Dollar and treasuries. And although the yield on the 10-y treasuries is less than 2%, purely as result of the Fed action and thus are not reflecting the default risk in the US, US treasuries in our point of view are purely being sought after for technical reasons, it is the only market ($10trn) that is liquid enough in order to enable large sums of money to move in and out when needed. And thus the US treasury market can be seen as a “storage facility” till investors know in which asset classes they want to invest in.

It is an illusion to believe the US is in a better shape than Europe

We want to emphasize that from a fundamental point of view we don’t believe that the US market is in any better shape than the European markets with US monthly deficits totaling on average $110bn a month in 2011 and showing a record deficit of $223bn for the month of February. The Super committee was not able to reach an accord, triggering automatic cuts that only kick in 2013 (so much for dealing with an acute deficit problem), in order to save at least $1.2trn over ten years (only $120bn a year!!) whilst the debt ceiling was extended by $2.1trn, which is most likely to be used up by year end 2012. It is clear that Washington is not serious in actively dealing with the US debt problems. Same old story: no leadership! This is a sign of the times we are living in which will continue as long as the politicians can get away with it.

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