Key News
* EU announces 750-bln euro crisis shield with IMF (Reuters)
* ECB to Intervene in Bond Market to Fight Euro Crisis (Bloomberg)
* USD funding costs drop as Fed swap lines revived (Reuters)
* BOE Leaves QE Unchanged Stg200bn; Bank Rate Unch At 0.5% (Market News)
The Event Agenda
Afternoon Run-Down
The scariest development last week in global financial markets was the sign that credit was tightening … banks were starting to become more concerned with counterparty risk, hesitating to make short term loans to other banks … i.e. global credit (especially dollar based funding) was starting to look like another 2008 credit freeze was underway.
It all boils down to the deterioration in Europe. Europe’s crisis started with market concerns over shaky sovereign debt scenarios within the euro zone, which quickly exposed the structural flaws of the monetary union. Both of these problems escalated the crisis last week into a potential second round of a global financial crisis.
With disaster looking like a serious possibility, Europe rolled out threats of massive intervention over the weekend in a desperate effort to calm the government debt markets and the growing fear in the European banking system. This is like firing tear gas into the crowd of bond market speculators. They also gave financial markets a clear sign that they will not let a country fail—at least any time soon.
This takes a default scenario or an exit of a member country from the monetary union off the table—for a while, at least. It shows all of the sixteen members are stuck in this battle to save the monetary union because of the systemic nature of the sovereign debt crisis. The European banks are too exposed and would death-spiral if a member country were to default or exit the euro.
So on Friday evening, the Emu leaders announced an “all-in” approach. With it, they outlined a road of austerity for all euro members. And yesterday they followed with the big guns including a 750 billion euro fund to show the extremes they will go to stabilize the weak euro zone countries. They also announced that they will be intervening in government bond markets – a clear warning to bond market speculators to back-off.
The European Central Bank is in too. They’ve already relaxed rules to accept junk bonds as collateral and now they are buying up government bonds … i.e. printing money.
An important development for currencies, the Fed reinstated its currency swap lines for global central banks. This was key in releasing the pressure valve on the credit freeze in 2008. Global banks can now part with dollar loans more freely, supplied by the Fed. This ultimately had a negative effect on the dollar after the 2008 crisis moderated. But the problems now are different. It’s about sovereign debt. And the austerity measures taken in Europe will likely be played out in other spots around the world, putting a global double dip recession back in focus.
Key Charts
Euro
This is the weekly chart I showed last week. This eight year trendline gave way. This week’s data doesn’t show up on this chart until the Friday’s close, but today the euro has tested this red line (now resistance) and fallen back 276 points.
With euro-wide austerity, money printing and a re-write of the euro’s founding principles in the plans, look for euro to go much lower.
Risk Premium for Greek Debt Collapsing
Greek yields were driven up to a nearly 10 percentage points higher (the white line) compared to yields of its fellow monetary union member, Germany (the orange line). With the announcement of the massive Emu backstop of Greece, that spread has collapsed …
British Pound
With Europe going all out to defend against a default in the euro zone, the next candidate for sovereign debt scrutiny is England. The UK is on the clock to produce a credible plan for curtailing deficits, which should prove difficult given the political uncertainty.
Fed Swap Lines
The Fed agreed to give foreign central banks U.S. dollars at a determined exchange rate for the currency of the respective foreign counterpart. And when the swap ends, the two central banks simply repay the same quantity of currency back. There’s no exchange rate risk and no impact on the demand for currency in the open market.
