Well, after yesterday’s utter carnage in European government bond markets with not even Finland – ironically, the only country within the Eurozone to actually *STILL* meet the Maastricht Criteria – being slotted as players try and sell anything they can, TMM reckon we are getting very close to the end game.
It’s pretty clear that liquidity in European bond markets and the price action within them has now become completely disorderly, non-functioning, and at the point of seriously impeding the flow of credit and transmission of the ECB’s monetary sadistic policy. The front-ends of the core countries of Holland, Finland, Austria, have all sold off between 25bps and 100bps over the past few days, something TMM would argue constitutes a de-facto monetary tightening in those countries. Given these are, arguably, not the “profligate” iPIGS, a sound monetarist like the Bundesbank would loosen monetary policy. TMM reckon policy action is imminent…
…The question is, “by whom?”.
TMM have been debating precisely what is going on behind the scenes, as to whether the Axis of Evil are merely ignorant to the seriousness of developments, or whether this is all part of a grand plan driven by Realpolitik. And TMM have come to the conclusion that it is a gigantic game of chicken… Not between the ECB and Italy or whoever. But between France and Germany.
The former is desperate for the ECB to do the heavy lifting, especially so given that their AAA-rating is the one at risk when it comes to EFSF leveraging and the oncoming Euroarea recession. Germany, however, wants to push for “More Europe”, with the EU being able to have a veto on national budgets and balanced budget rules across Europe – i.e. fiscal union on Germany’s terms. The French, eager to avoid surrendering to the Germans… Again… Hope that Germany blinks first, and allows the ECB to step up. Yesterday’s comment from Schaeuble, contradicting Buba’s Wiedmann, coupled with German Wiseman Bofinger’s warming to this idea suggest that the domestic economic debate and political stance are close to backing down. TMM would expect given the kicking the rest of Europe has been given the past few days that some of the Axis of Evil begin to defect, and the ECB’s Nowotny on Friday was a notable example of this. But, with French 10yr OATs approaching 200bps, the pain level in the Elysee Palace must be approaching capitulation levels.
Who will blink first?
All TMM will say on this – as far as relevant analogy goes – is that in November 2008, when Fannie and Freddie AAA bonds were widening sharply in response to indiscriminate deleveraging and general selling of anything related to those entities, the Fed capitulated once this paper got up to 195bps intra-day and began buying MBS in size.
Something TMM have often shaken their heads in despair at is the perennial determination of commentators and market participants to present the “Theory of Decoupling” (repeatedly resulting in a massacre of EM assets) and “The New Safe Haven”. The former theory builds over time as punters form the opinion that their portfolio has some uncorrelated trades, then all of a sudden there is a dramatic leverage-driven unwind that blows said portfolios out of the water, and the theory dies for about 9 months (Asian FX). The latter, however, appear in a sudden rush to buy a currency/asset, with strategy and sales notes spouting the virtues of said country. Said Nuvo-safe haven will then embark upon a worrisome backslide toward the level at which it traded prior to its status elevation and then promptly resume trading like the cyclical beta asset it always was, sending everyone off looking for finger-burn remedies. TMM have witnessed this with the Singapore Dollar, the Aussie and most recently, with the Swedish Krona (SEK)…
Now, TMM agree there are loads of reasons to love Sweden, not least the quality of their gene pool, but, as with many other exoduses to new safe havens, neither the numbers nor the fundamentals stack up. When thinking about what you might want in a safe haven, the key things are: (i) somewhere large enough to park your cash in a liquid manner, (ii) somewhere safe enough to park your cash, (iii) a current account surplus to remove capital flight risk, (iv) low government debt to help provide (ii) and prevent (iii), and (v) low beta to the global economy. Now Sweden certainly satisfies conditions (iii) and (iv), and its government debt is certainly safe enough to satisfy (ii). However, with respect to (i) and (ii), there are distinct differences with, say, Switzerland.
In Switzerland’s case, while there isn’t much in the way of a bond market, there is a very large banking sector with a long history of providing safety for investors. However, Sweden is distinctly lacking in this respect: the stock of outstanding government debt is rather small, at less than $200bn (see chart below, orange line), and its banking system just isn’t big enough. And while certainly, since the Eurozone crisis erupted there has been a flow of money into Swedish banks (white line – non-resident Swedish bank deposits, $bns), it has been a small net ~$31bn and has actually reversed over the past few months.
As far as point (v) goes, in developed market terms, Sweden is well-known to be a pro-cyclical market. The below regression of the change in Swedish YoY GDP vs. that of the Eurozone confirms its high-Beta status (1.67 since 1995) .
So TMM reckon it is hard to label the Krona a “safe haven” and are wondering if perhaps it has become the next Vengabus. Given the economic linkages with Europe, TMM reckon there is a trade here. Looking at Swedish Export growth (see chart below – blue line), a regression against Eurozone, US and UK import growth (red line) explains most of Sweden’s export behaviour. But drilling down, it seems clear to TMM that the bulk of the variance is driven by Eurozone Imports (green line). As far as TMM can tell, Sweden is just a leveraged play on European growth which, coincidentally, is going right down the Swannee…
…In recent months, Swedish economic data have disappointed, inflation has peaked and the curve begun to price in rate cuts. Additionally, the growing noise around EU bank deleveraging is likely to have a negative impact upon the asset quality of Swedish bank operations in Eastern Europe. Second-order feedback effects indeed. It thus surprises TMM that despite the curve pricing in rate cuts and financial volatility spiking that EUR/SEK has not really rallied much and when compared with a (very) naive model base upon rates spreads and the VIX, it seems too low to us…
And at a time of little divergence from Risk-On/Risk-Off, it’s interesting that EURSEK’s correlation with such factors has been pretty low of late. So, in the interests of adding low correlation trades to their book, TMM reckon scooping up some EUR/SEK is not a bad play but to avoid that Euro thing will instead go long GBP/SEK.
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