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The European Central Bank is the only game in town and Germany's Merkel is all that stands in the way of central bank intervention
11/17/2011 4:50 pm EST
Yields on 10-year Italian bonds over 7%--as level that everyone calls unsustainable. Yields on 10-year Spanish bonds approaching 7% in today’s auction. Yield spreads between French and German 10-year bonds rising to 2 percentage points, level not seen since the introduction of the euro. Yields on Austrian and Dutch bonds rising as that debt too comes under pressure.
The cry to unleash the European Central Bank is coming from all corners of Europe—except for Germany.
In Berlin today Chancellor Merkel lumped large-scale bond buying by the European Central Bank together with new euro bonds and a debt cut as proposals that won’t work. “I’m convinced that none of these approaches, if applied right now, would bring about a solution of this crisis,” Merkel said. “If politicians believe the ECB can solve the problem of the euro’s weakness, then they’re trying to convince themselves of something that won’t happen.”
I actually think Merkel is right. None of these steps would “solve” the euro debt crisis. That will take something like the changes to the euro treaty and the deeper political union for euro countries that she has proposed—plus years of economic reform in currently uncompetitive EuroZone economies such as Italy.
But being right doesn’t count for much when the house is burning down around you. Europe’s political leaders are in close to panic mode. Today outgoing Spanish Prime Minister Jose Luis Rodriguez Zapatero called on the European Central Bank to act immediately. These leaders know they have to do something now or a crisis that may already be out of control will become irretrievably out of control. And Merkel isn’t offering anything that addresses that near-term panic or that would buy time for the long-term solutions she suggests.
So how much longer will Merkel hold out—and how much power does she have over the European Central Bank?
I think we’re days away from seeing some kind of face-saving deal that gives Merkel a commitment to the kind of long-term change that she has advocated but that throws the European Central Bank into the markets full force in an attempt to end the panic. Every hour that goes by, every basis point rise in Italian, Spanish, and French bond yields makes Merkel’s position and that of the German-wing at the European Central Bank less tenable.
What is the alternative to massive European Central Bank intervention? I don’t see one. Over the last few days the financial markets have made it clear that they don’t care about a new government taking power in Greece or promises from Italy’s new Prime Minister Mario Monti. We’re beyond the point where political change like that makes any impression on bond yields.
As Willem Buiter, a former member of the Bank of England’s monetary policy committee and current chief economist at Citigroup said in an interview on Bloomberg TV yesterday, the ECB is “the only remaining show in town.”
You know that Merkel is feeling isolated when she reaches out to Prime Minister David Cameron, due for a visit to Berlin tomorrow. The United Kingdom isn’t even a member of the EuroZone and Cameron is under political pressure at home from members of his own party who opposed any closer integration between the United Kingdom and the European Union. (Since he’s currently detested by the French Cameron might make an ideal go between for a deal over the European Central Bank.)
Merkel wouldn’t be looking to Cameron as an ally if Germany’s relationship with France hadn’t turned so negative in the last few says. The government of Nicolas Sarkozy, which had reluctantly backed the German position on the European Central bank, has turned into an advocate of intervention now that French debt too is under pressure. Yesterday French Finance Minister Francois Baroin told the French Parliament that European Central Bank support for Europe’s recue fund is the best way to counter the debt crisis. The French have repeatedly argued for granted the European Financial Stability Facility a banking license that would give the EuroZone rescue fund the same rights to tap into the central bank as European banks have now.
And you know that patience in Europe with Germany is wearing thin if suddenly Germany’s deep fear of inflation—related to the hyperinflation of the 1920s that brought down the Weimar government and paved the way for Adolf Hitler’s rise to power—is coming up in speeches from other European leaders. The thrust of these speeches, however, is that Germany needs to just get over it.
As Citigroup’s Buiter told Bloomberg TV, “We’re not asking for Weimar.”
Today the U.S. Standard & Poor’s 500 index finished the day near the 1209-1215 bottom of its recent trading range. (The top has been 1295.) Absent big action from Merkel and the European Central Bank I think we’ll go through that level in the next few days—and that could lead to an even bigger downside move as the market looks for its next support level. The big worry here is that the August low is at 1124 and the October 3 low is at 1099.
None of these technical levels will matter if the European Central Bank moves strongly. If it doesn’t, I think we could well see a complete retrace of the move up from the October 3 low.
Which, of course, makes this a hellish market to invest in. On the one hand, you risk seeing your portfolio drop along with another 100 point decline in the S&P 500. On the other hand, if the central bank does move, and you’re out of this market, then you’ll miss the rally back to the top of the range at 1295, in my opinion.
As I wrote on November 10, the euro debt crisis is now clearly a political crisis http://jubakpicks.com/2011/11/10/europes-financial-crisis-is-now-clearly-a-political-crisis-which-unfortunately-may-make-it-harder-to-fix/ . How good are you at reading the political tea leaves?
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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