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Bill Blain: “If The ECB’s Bond Buying Largesse Is Over Get Set For The European Debt Crisis Part Two”

Wednesday, October 5, 2016 5:14
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(Before It's News)

With the rumor, or at least trial balloon, of an ECB taper rocking bond markets and pushing EM equities lower, a dire forecast has emerged from Mint Partners’ head of capital markets Bill Blain who in his latest note warns that “if the ECB’s trillion-billion bond buying largesse is over – then get set for the European sovereign debt crisis Part Two as markets focus back on debt fundamentals.”

Here’s why:

Interesting (in the Chinese sense of the word) day in the European bond markets y’day. Even as Italy launched and priced its 50-yr bond – a Euro 17 bln book for a 5 bln deal priced in line with Spain – the European markets suddenly stumbled and tumbled on mumble-swerve the ECB is “considering” to “Taper” its bond buying programmes.

The story has some credibility after the ECB didn’t extend the programmes at the recent meeting. Watch carefully how that pebble of doubt develops in coming months. I reckon it heralds the avalanche.
All it will take is a few more headlines talking about “the ECB is considering a way to end its bond buying”, and some unwise words from EBC talking heads – and its game-over and the Emperor’s new clothes moment for the most distorted market on the planet – Euro Fixed Income.

No one is pretending for one moment the reason European sovereign bonds across the EU are trading in NIRP territory is due to their magnificent credit quality. The fact middling corporates can borrow at negative rates is madness.

If the ECB’s trillion-billion bond buying largesse is over – then get set for the European sovereign debt crisis Part Two as markets focus back on debt fundamentals.

And this time.. it will be serious.

What we saw yesterday was a quickly denied mini-taper-tantrum. But it highlights the massive risks overhanging European bonds if the faith in the depth of the ECB’s pockets is tested.

The fact Italy – yes.. ITALY..! – is able to fund 50-yr money at less than 3% means long-term ruin for the European insurance companies that we’re forced to buy it. For the deal to make any kind of sense European rates have to remain low for ever. As more than one buyer asked me yesterday – “are they serious?” But, yes, they were serious to the extent of Euro 17 bln!

So what game is Draghi playing by even thinking about letting doubt creep into the market? It’s become almost a mantra of faith the ECB buys forever.

Suddenly there are these multiple vectors of doubt.

I can’t promise a flood of naked truth – we simply don’t know. But, what happens if the ECB no longer backstops European sovereigns to issue long-term debt at ultra-low rates while corporates are able to do zero-rate deals? Even Eastern European sovs are benefiting from low rates and funding close to zero.

While investors have piled in on the coat-tails of the ECB – pushing prices higher, ZIRP and Zero rates are causing pain and anguish across the European financial sector – especially in Germany where the evidence is mounting that local and regional insurance companies were utterly unprepared for this rate environment. Their mismatches will create future crisis on an unimaginable scale. Massive bailout needed.

And Germany is the hint – a fact immediately spotted by a good chum of mine who just happens to be a leading US academic economist. His logic is simple, and he was lightning-quick to connect the dots:

  • The EC’s NIRP policies are hurting most in Germany where banks and institutions are caught in low rates/low margin financial purgatory. What happens next?
  • At some point soon the Germans will be forced into a two-pronged rescue of banks and insurance companies – a move that would green-light the rest of Europe (especially Italy) to engage in similar rescues. Result? More debt but ultimately fixed banks. Massive NPL issues “addressed” and losses realised.
  • Or, the Germans continue to resist rescue, but as the economy recovers (slowly) they argue for higher rates (causing further division across Europe).
  • Part of the inevitable compromise to keep Europe together will be abandonment of the ECB’s capital key, some loose talk about monetary and fiscal union, and the de-facto debt mutualisation of Europe’s

Sovereign liabilities as Draghi’s ECB effectively makes a looming European Sov Debt crisis disappear by buying absolutely everything for ever.

It’s frightening to think back to how the European sovereign debt crisis became an avalanche just a few years back. Draghi was forced to step in and stabilise the situation in December 2012 by promising unlimited liquidity to banks in the form of TLTROS– the unsaid agenda being that money would be used to buy sovereign debt to stabilise the collapsing sov debt market. The result was the spectacular 4-yr rally in European debt – Spain from 7% in Dec 2012 to 0.5% today..

Perhaps the only way to stop the European House of Cards collapsing will be to do a Francis Urquart.. doing exactly what you said you wouldn’t with a lizard smile on your face and pushing it as your own idea. Who would want to be the next Angela Merkel? 

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