Friday, August 3, 2012

No left tail for a while

Two weeks ago we had:
- Markets nervous because if Spain and/or Italy had to access the EFSF/ESM for help there would be limited firepower as they’re too big for the previously available funds.
- History has shown that when the limit and scope of help is defined a magnet is created and markets would push prices to the worst-case boundaries as has been the case in the past 3 years in the Euromess, followed by some kind of intervention

What has changed:
- Now Italy and/or Spain will, if markets force them to, apply for the rehab programs (EFSF/ESM)…
- Which will force them to adhere to conditionalities…
- Which a/ don’t seem to be too dramatic (or away from what’s priced in…) and
- b/ which are pre-requisites for Germans to accept the ECB’s posture of using much larger (possibly unlimited?) firepower alongside the already committed capital of EFSF/ESM buying bonds IF NEEDED

For now (the next 3 minutes I guarantee) the price action in banks + ITA+ESP bonds has been very good (equities up, bonds bull steepening), meaning there is some time before doubts arise.
As was the case in 1Q09 in the US… without limits in firepower (TARP/Maiden Lane, TALF, QE1) we’re possibly looking at a game changer here, at least for some time…

Triggers for markets to actually reverse course and go down in the near term are:
A/ global activity being MUCH worse than expected (as a lot of it is already priced in if you just look at other equity indexes other than the SPX or the DAX)
B/ the conditions under which Italy/Spain would be put under were too severe (unlikely in my humble opinion), cutting into economic activity too drastically and offsetting any improvement in bond yields and credit transmission…

To watch are the same variables: Target2 Claims, Deposit Flights and banks’ equities and credit. These are the ‘convertibility premia’ Super Mario pulled as excuses to get the bond buying within his mandate.

To a good weekend.