Trichet is bidding adieu at the end of October and this was his last opportunity to reverse the prior rate hike. But he chose instead to ride off to the Hotel du Cap without admitting to one of the worst policy decisions in the history of the ECB.
I doubt he is ceding the white hat opportunity to Mario Draghi, allowing him to cut rates at the first meeting he will chair in November. Perhaps the economic releases yesterday morning may spur the correct decision, in conjunction with recent declines in commodity prices even though Trichet has taken the other side of the inflation trade. Eurozone services PMI fell to 48.8 from 51.5 according to Markit survey, the first month since August 2009 below 50. In other releases, Germany was sub 50 as well, France barely above 50, Italy and Spain continue below 50 at very low levels of 45 but they are already in recession. My guess is that France and Germany experience contractions in economic growth as well.
More importantly, does the troika come up with a major bail out prior to Trichet leaving and before Draghi takes over? Not sure how many EU members want an Italian telling them they have to pony up vast sums to save Italy. Fox guarding the chicken coop? Not quite but this will ratchet up the opposition or lengthen the time to cure if Trichet doesn’t act first.
The Financial Times had the story that wasn’t a story (as updated by FT on 10/5 (click here). On Tuesday, the following two lines squeezed the shorts, lit a fire under those with light exposure and gave us all something to talk about.
“There is an increasingly shared view that we need a concerted, coordinated approach in Europe while many of the elements are done in the member states," Olli Rehn, European commissioner for economic affairs, told the Financial Times. “There is a sense of urgency among ministers and we need to move on."
“Capital positions of European banks must be reinforced to provide additional safety margins and thus reduce uncertainty," Mr Rehn said. “This should be regarded as an integral part of the EU’s comprehensive strategy to restore confidence and overcome the crisis ..."
Rehn’s statement was nothing more than an attempt to put a temporary halt to the market crisis, an admirable goal, but hopefully there is ultimately more substance behind it. With the public division in the EU about solutions, I fear any resolution will be a long time in coming. Even the ESFS is flawed with Italy and Spain committing to guarantees of 79 billion euros and 52 billion euros, respectively. And, of course, Greece has agreed to be on the hook for 12 billion. I feel better now.
So the market basically did a hosanna now that it has dawned on the EU finance ministers that they have developed a sense of urgency and should act together. Truth is we don’t know that they will act together but ultimately there has to be a plan. Unfortunately, from where I sit, the plan won’t be good for anyone, particularly the banks. We need a flush of the credit markets with tremendous pain being visited on the private sector because the political will for government to bail out all troubled banks and PIIGS does not exist. The result would be to wipe out the equity of a number of French banks as we are seeing with Dexia, which was originally bailed out in 2008 by France and Belgium.
Now here they go again. Public shareholders have twice suffered significant losses. Dexia (OTC:DXBGF) is also a good example of contagion as the municipalities in the U.S. that do business with Dexia will likely see their borrowing costs increase as a result. And this is a minor case of contagion. It will get worse (plus the 2008 similarities continue with good bank/bad bank solutions that don’t work).
My bet is that Greece defaults in a “controlled" manner (not sure that exists) with limited alimony payments from the EU as a going away gift. At the same time, Italian and Spanish debt issues are ring fenced, the French banks recapitalize after taking significant write downs which almost wipes out equity holders with new shares or debt being backstopped by Germany and France as the main players. France loses its AAA, which is past its sell-by date anyway. We will also see massive liquidity injected into the European financial system causing a further decline in the euro.
I have been slightly increasing my equity exposure because I expect it to be off to the races once a plan is announced. But there are too many potential negative data points in the interim to have any more than a small long position. However, I have taken off my shorts. I'm not worried about missing the first ticks higher. Once "the plan" is announced, we go higher but then economic reality takes over and it's back down. With the slowing in China, Europe and the U.S., I’m highly confident that I can get a better entry point and keep more hair from falling out.