What If They Just Say Nein?

Daily State of the Markets
Thursday, June 28, 2012

Good morning. Sometimes it is a good exercise to try and boil a problem down to “just the facts, Ma’am.” So from my perch, the European debt crisis is really about three things: (1) Too much debt, (2) not enough income, and (3) a lack of confidence in the ability for the countries in question to make improvements on either of the first two scores. As such, traders (aka the evil bond vigilantes) vote with their feet and continue to sell the bonds of countries like Spain and Italy, which, of course, causes rates to rise. In turn, this increases the interest expenses of the countries involved, which makes the problem ever worse.

For those keeping score at home, the aforementioned downward spiral in Spain and Italy is rapidly approaching the point of no return. Just yesterday morning, Spain made this point perfectly clear. There is little doubt that the words of Prime Minister Mariano Rajoy were intended to make a very public point prior to the latest (and greatest) EU Summit. However, Mr. Rajoy didn’t appear to be mincing words when he told his parliament, “We can’t finance at current prices for too long.” The PM then went on to say, “There are many institutions and financial entities that have no market access. It’s happening in Spain, it’s happening in Italy and in other countries, that’s why this is a crucial issue.” Rajoy then publicly begged EU leaders to create something (anything!) to deal with the matter of refinancing debt – and he used the word “urgent” in the process.

If the Spanish PM is to be taken at his word, then the situation in his country looks to be quite dire and perhaps worse than most folks in the west may realize. What’s more troubling though is the situation has a certain d?j? vu all over again feel to it. Recall that it was when banks became frozen out of the credit markets in the U.S. that the credit crisis went into high gear in 2008.

Thus, it is not surprising that the likes of Italy, Spain, Portugal, Greece and even France are calling for the EU gang to do something – and fast. Something like jointly issued bonds, or a jointly backed bank deposit insurance “scheme” (I still love how the Europeans apply that word), or the ECB hitting CTRL+P in order to stop the “unwarranted attacks” on the debt of some countries (this was my personal favorite line from yesterday’s session as it reminded me that Lehman had no liquidity problems on the Friday before their bankruptcy).

To hear Mr. Timothy Geithner tell it, the Europeans need only create joint bonds or an F.L.A. (a four-letter acronym such as TARP) which involves a bunch of bonds in order to put their problems to bed. Apparently our Treasury Secretary continues to ruffle euro-feathers with his position on the subject each time the G-20 has a dinner date. And perhaps the person most annoyed by the idea of fixing the debt problem by creating a whole lot more debt is Germany’s Angela Merkel.

As anyone following the crisis probably knows, Ms. Merkel has absolutely, positively no interest whatsoever in getting involved with any of these fancy “schemes” unless there is something akin to the USofE put into place first. Thus, the German Chancellor has become well known for her use of the word “Nein!” when asked about any of the half-baked plans to “fix” the Eurozone. (Zerohedge had the best Tweet this week on the subject: “Merkel, Angela Merkel, party of nein!”) You see, Ms. Merkel has the silly notion that you can’t fix a debt problem with more debt. She also gives the impression (and rather emphatically) that there is no way in heck that she and the rest of the German people are going to go on the hook for the good times run up by the budget-buster countries without first being in charge of the PIIGS.

As Merkel has opined on many occasions, there doesn’t appear to be a quick or easy solution to the European debt mess. However, the stock market here is the U.S. isn’t acting like there is a big problem at hand. Perhaps this is due to the assumption that the ECB will ultimately cave and keep hitting CTRL+P until those evil bond vigilantes cry Uncle. Or maybe stocks are still in good shape because traders believe that there actually is a bazooka (a globally coordinated response by the world’s central banks). Or maybe, just maybe, traders figure that Mr. Bernanke himself will mount yet another of his cavalry charges and save the day. But at the end of the day, there is also the base assumption that Germany will eventually say “Ja” and do whatever it has to in order to keep the Eurozone together.

However, as Egan Jones (aka “Egan Who?” on Twitter) demonstrated this week, even Germany isn’t big enough or rich enough to back the whole EU mess. If you recall, the Egan Jones downgrade of Germany was based on the concept that if Germany is outvoted and actually does have to take on more responsibility for the PIIGS, then it’s credit rating needs to be cut.

However, the question I find myself wrestling with the most right now is what happens if Ms. Merkel and her countrymen just say “Nein”? After all, the Eurozone needs Germany a whole heck of a lot more than Germany needs the EU. And while admittedly the possibility of such an event is slim, my point is there might be a tad more risk out there than stock prices are currently factoring in. But then again, Germany is sure to cave at some point, right?

Turning to this morning… Futures are pointing to a lower open at the moment on a report that JPMorgan’s trading loss could reach $9 billion. In addition, China’s Shanghai index was lower for a 7th consecutive session. However, the futures did perk up a bit after word that Germany’s Finance Minister appeared to suggest that Germany was changing its tune on Euro bonds. Of course, the position was immediately clarified and Germany’s stance has not changed. Finally, we need to be ready for the Supreme Court Ruling on Obamacare at 10:00 am.

On the Economic front… Initial Claims for Unemployment Insurance for the week ending 6/23 were reported at 386K, which was below the consensus estimate for 387K but a bit above last week’s initially reported total of 385k (which has been revised up to 392k). Continuing Claims for the week ending 6/16 came in at 3.296M vs. consensus of 3.279M.

Next up, the government reported that GDP in the U.S. for Q1 came in at 1.9%, which was in line with the last revision and with consensus expectations.

We’ll also get Bloomberg Consumer Comfort at 9:45 am.

Thought for the day… Happiness depends upon ourselves — Aristotle

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell…

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• Major Foreign Markets:
  • Australia: +0.04%
  • Shanghai: -0.95%
  • Hong Kong: -0.79%
  • Japan: +1.65%
  • France: -0.96%
  • Germany: -1.62%
  • Italy: -0.46%
  • Spain: -0.12%
  • London: -1.23%
• Crude Oil Futures: +$0.13 to $80.34
• Gold: -$10.70 to $1567.70
• Dollar: higher against the yen, euro, and pound
• 10-Year Bond Yield: Currently trading at 1.602%
• Stock Futures Ahead of Open in U.S. (relative to fair value):
  • S&P 500: -6.90
  • Dow Jones Industrial Average: -74
  • NASDAQ Composite: -13.93

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