We observed early this year that the curious process of consulting firms becoming fund of fund managers was becoming more common. As Niki Nataranjan acutely observes in her recent piece investors are going to find it more and more difficult to distinguish between advisors, managers, and consultants. The crunch will come in two ways. First of all, in the classic consultant model, performance was something to oversee, not to produce. The two are rather different, and require different skills. Further, it is not clear how these manager-consultants will react to negative performance or negative relative performance. Will they fire themselves?
Two months seem to be a very long time in finance and politics. It didn’t take much for the Draghi effect to translate into lower spreads and record bond issuance by European banks and other corporates. Until last August, the likes of Unicredit, Monte Paschi, Banco Popolare, but also Enel and Generali, were having a tough time to issue debt at acceptable cost. Even the Italian government had to pay record yields on short dated paper. However in the last 60 days everything seems to have changed. Paper issued in the summer is now trading ten points above, and all the above issuers have inundated the market with new issuance at continuously tighter spreads. Even the famous Bund/BTP spread has tightened back to 330bps. Retail investors seem they cannot get enough of it.
The market is clearly back to Risk-On, and big time, but the question as always is: will it last? If we take the US version of QE, the answer is that it may last for quite some time, and we are hearing that hedge funds and other pundits who were caught not long enough are continuing to add to positions. However, Europe is different, because unlike the US where there is only one person talking at one time, Europe will continue to be a cacophony of different spins and interests. Currently the odds seem to have turned back in favour of keeping Greece in the Euro and allowing Spain to use the EU facility with minimum stigma…but we wouldn’t bet on a smooth ride.
A few months ago we commented that Draghi had to threaten to use a bazooka in a similar way to how the SNB does to keep the CHF at acceptable levels for Switzerland. As it happens Draghi wasn’t able to get the Germans to agree to a Swiss style ‘red line’ on yields, but by pledging unlimited firepower, he has made the first real and solid attempt at keeping the Euro zone together since the crisis started.
Also worthy of note is the fact that he has compressed the BTP/Bund and Bono/Bund spreads probably without any meaningful purchase for the time being, but rather relying on the ‘announcement’ effect. Should he need to make sizeable purchases in the future, when the markets will test him (note, when, not if…) he will sterilise the creation of money supply with bill sales, thereby comforting the Bundesbank on the inflation front.
We all know that the Euro zone’s definitive solutions must be political, but by using an umbrella first, with his August pronouncement of ‘we will do all that is necessary’ and with his September unlimited bond purchases pledge, Draghi has gone as close as he could to the bazooka effect. Bravo!
This article was written by Emanuel Arbib – check out the Google+ profile for more updates.
Draghi’s comments at the ECB press conference are yet another attempt to buy time without deploying the bazooka that the markets have been looking for a long time now. However, as unpalatable as it will be to make use of it, it does give Spain and Italy an ultimate parachute should things turn really ugly. This should be seen as a positive development and a clear message that if all else fails, the Euro will be saved when a (fiscally responsible) member state in trouble asks the ECB for assistance, and this will be given.
The problem is still the same, markets will test nations and the ECB to the brink, and this could mean Spain losing market access in the next weeks, at which point the market will test exactly how this ‘bailout of last resort’ works in practice.
I’ve just been quoted in a Reuters article about European bank shares rising. Here’s the article.
One of the benefits of European monetary integration was going to be the elimination of the uncertainty of the movements in currency rates so as to increase cross-border transactions and create the largest ‘domestic’ market in the world.
In order to remove that uncertainty the architects of the euro have unfortunately created much deeper anxieties and uncertainties. The reality in southern Europe right now is that savers are spending their time trying to protect their wealth from the spectre of bank failures, devaluations, and capital controls. Investors are demanding a high premium to invest in Italian and Spanish bonds, and entrepreneurs have to compete in an open global market with German (and French for the time being) competitors paying a fraction of their cost of capital. These economic distortions pale in comparison with the old threat of a lira or peseta devaluation of yesteryear.
The main point to consider is that these economies, including those like Spain and Italy which are on the path to fiscal consolidation, will never be able to meet their deficit targets with the real economy slowing down and going backwards due to the combined effects of increased taxation, lower disposable incomes, high relative interest rates, and anxiety about the future. The longer it takes to find a real solution, the more painful it will be to solve the issues at hand, without discounting popular discontent which at some point may force a reversion to populist measures.
Back in November, Monti’s popularity was such that he could have imposed to parliament and to the country measures that would have been impossible to even discuss for the previous governments. His power was not due to the usual honeymoon effect, as here there was no election and no love, only fear of national bankruptcy and the general consensus that if there is someone that can save Italy, it is Super Mario.
Eight months later, the day after parliament finally passed the most complicated bill introduced by Monti (which had to be pushed with repeated confidence votes), the Labour bill, things are quite different. It is possible, even if not likely, that Monti will have tried to pressure his European colleagues at the summit currently underway that unless he comes back home with a tangible result from his list of requests, he will resign. It wouldn’t be an empty threat. Monti knows that his power base, the Italian people, has eroded as Italians have seen the famous ‘spread’ return back near the levels last seen during the last days of Berlusconi’s administration. Simply put, Italians agreed to tighten their belts without too much complaint but were expecting in return to be able to return borrowing at European and not South American rates, to see Italy diverge from not only Greece, but also Spain, Portugal, Cyprus.
Unfortunately, this hasn’t happened and there are two main reasons for this, the first endogenous and the other one exogenous, as Monti himself would have said in his Macroeconomics classes. The exogenous variable is the continuation of the European crisis which sees markets continuing to go after the next perceived weak link. When Spain’s banks got bailed out, Italy’s started appearing in the crosshairs. Monti is quite appropriately trying to address this by persuading Ms.Merkel that the markets need some short term mechanism that automatically speed-limit the borrowing costs of Italy, Spain and the like to deviate too much from Germany’s. We will know soon if he succeeds. The internal issue is that Monti’s government ended up watering down its initial promises and has had to acquiesce to the political games in an even greater way as ‘normal’ governments, as he has no constituency in parliament of his own. The main example is the Labour bill: nobody likes it because it didn’t really achieve anything. Ms.Fornero had a historical chance of rewriting the book on Italy’s terrible labour laws but only achieved to change a few footnotes.
I contributed a comment on a recent UK Reuters piece about on-going European market volatility. The article can be found here.