A really good note from Nomura’s Guy Mandy outlines a way for the euro crisis to be resolved (again) for now.The gist: Tap the crisis mechanisms now to show that they work. Don’t wait.
There needs to be rapid clarification of what exactly these crisis resolution mechanisms mean to the market and current debt holders. Portugal’s finance minister Fernando Teixeira dos Santos has said that Europe needs to clarify the mechanism to tackle the crisis. Ireland CB governor Patrick Honohan was at pains to point out that Germany’s proposal for a sovereign restructuring mechanism is for the future and will not affect current bondholders. Honohan said the suggestion that private bondholders should shoulder losses in future sovereign debt crises had helped to destabilise markets. Although Honohan is an ECB member, his non-political role is such that he is relatively powerless to persuade the market either way. What is required is possibly the presence of Schaeuble himself alongside the other Ecofin members making a clarifying statement in this regard. We believe this is increasingly likely although we are concerned that the lack of a clear signal in fact implies the lack of resolution over a clear policy.
Alternatively, Ireland would need to go to the EFSF quickly. This would be a powerful signal and the EFSF is at this stage functional. We give this a very low probability though in the immediate future. While many would conjecture that the EFSF is an eventuality in the coming year, there is even a chance that Ireland may not need to access it. The 2011 target issuance for Ireland is probably in the order of €15bn once pre-funding during 2010 is taken into account. A move by the government in getting the Irish pension funds to buy debt government debt could in fact sustain them through 2011.
And, the ECB could make large purchases through its SMP. The fact that the sell-off on Wednesday was during an auction day may temper concern. We expect a resumption of purchases on 11/11 in spite of the French and Belgian holidays. As we have said, there is a limit to the volume of bonds that ECB could purchase however as mentioned before, as this continues to drain liquidity from the market. And, as we have mentioned previously, we do expect a modicum of reluctance by the ECB given their objections to the EU plans. But financial fragility trumps other concerns.