For several months, markets have assumed the global economy has turned the corner, and better days lie ahead. The pundits felt that the U.S. economy would muddle through, perhaps not a 3% quarterly growth rate in the first quarter, but a respectable 2.5% for the first half. The strength of the U.S. economy combined with a resumption of Chinese growth would be enough to avoid a recession despite the never ending European problems.
Sure the crude price and the Iranian threat, a partial reason for the elevated oil price, is a drag on the global economies, but this situation has not deteriorated. Further, with the U.S. election looming large in less than seven months, the incumbent president will do just about anything to keep the gasoline price from advancing further, hoping to avoid a shortened career.
Since the U.S. non-farm payroll report, some of the numbers are changing, causing bears to emerge from hibernation. The poor NFP number was followed by an unexpected jump in initial U.S. unemployment claims. Continuing with the bear news, the U.S. Trade Balance dropped, as U.S. imports slowed down.
Last night the Chinese released a bearish number. Their GDP q/y report fell short of expectations, an increase of 8.1% less than the expected 8.4%. The bear news continued today with a drop in the University of Michigan Customer Sentiment report, dropping to 75.7 from last period's 76.2.
Naturally with the run of bear news, the QE III trio of Bernanke, Yellen and Dudley is starting to warm up, but the euro bankers may be the first to commence with the printing presses.
In retrospect it looks like ECB President Draghi's victory lap after the first Long Term Refinancing Operation in December was really a false start. Of the €500B of 1% three year money, the Spanish banks bought €67B of the government debt, and the Italian banks bought €54B of their government's debt.
There is a major problem here. The rates have gone up, meaning the mark to market of the loan portfolio has gone down, and the banks are losers. Since the Bundesbank says nein to further cheap loans there is a problem here. Normally the banks could borrow in the private market, however, private investors, aware of the "voluntary" haircut with the Greek reorganization, and the priority status of all ECB loans ahead of private loans means any private investor is crazy to lend banks that may need to be bailed out.
Another major problem, as reported by Bloomberg today, is the flight of capital from Spain and Italy. They report:
"In recent months, even as markets seemed calm, sophisticated investors and regular depositors alike have been pulling euros out of struggling countries and depositing them in the banks of countries deemed relatively safe. Such moves indicate increasing concern that a financially strapped country might dump the euro and leave depositors holding devalued drachma, lira or pesetas.
This analysis suggests that capital flight is happening on a scale unprecedented in the euro era - mainly from Spain and Italy to Germany, the Netherlands and Luxembourg. In March alone, about 65 billion euros left Spain for other eurozone countries. In the seven months through February, the relevant debts of the central banks of Spain and Italy increased by 155 billion euros and 180 billion euros, respectively. Over the same period, the central banks of Germany, the Netherlands and Luxembourg saw their corresponding credits to other euro area central banks grow by about 360 billion euros.
The seven-month increase is about double the previous 17-month rise, and brings the three safe-haven countries' combined loans to other central banks to 789 billion euros, their highest point on record. In essence, the central banks of the three countries - and, by proxy, their taxpayers - have agreed to make good on about 789 billion euros that were once the responsibility of Italy, Spain, Greece and others."
How long will it be until the voters in Germany, Netherlands and Luxembourg catch on to this recent ploy? Rest assured these tax payers are not knowingly assuming these dodgy loans.
The longer this continues, the messier it gets, and each new government administrated solution seems to make it worse.
As we suspected, the euro would be unable to hold a rally after a feeble turn around Thursday. Our preference remains the short side.
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