Thursday, May 20, 2010

The Euro crisis reaches panic proportions


As panics go, the current one is a doozy, eclipsed in modern times only by the Lehman collapse and the Crash of '87. Is Europe teetering on the brink of collapse? I suppose anything can happen, but surely it can't be very likely.

I think the explanation for the current panic is that investors are simply very skittish and the market is not nearly as liquid as one would like to think. Hair-trigger stop losses can overwhelm the market when the going gets tough. The panic feeds on itself. Pundits predict another calamity in the making. European policymakers do stupid things like prohibiting naked short selling.


With panic selling of equities comes panic buying of Treasuries. German 2-yr Bund yields are down to less than 0.5% (US 2-yr yields are 0.7%). 10-yr Treasury yields are down 75 bps from their April highs. As this chart suggests (my interpretation), yields at this level only make sense if we are on the verge of another recession. Yet there are simply no signs of a recession that I can find. Central banks are still very easy, yield curves are still quite steep, corporate profits are strong, commodity prices are still quite high, swap spreads haven't widened significantly, and many areas of the global economy are experiencing V-shaped recoveries.



Sovereign yields are very low, implied volatility is very high, gold is very strong and the dollar is up sharply against other major currencies, but the classic precursors of a recession are nowhere to be found—all this makes sense only in the context of a panic. When the panic subsides, prices are very likely to rise again, as this last chart suggests:

13 comments:

brodero said...

This is a article put out by
Toronto Dominion in January 2008 to predict a recession....

http://www.td.com/economics/special/bc0108_usrec.pdf


None of these indicators are close to flashing a recession.....

Christian S. Herzeca, Esq. said...

i would love to buy financials under current market conditions, but can't because of the uncertainty surrounding finan. reg reform....drat. will wait and watch

CDO Squared said...

Love the long term VIX chart. Great perspective.

brodero said...

The 52 moving average of nonseasonally adjusted jobless claims has been heading down since
October 2009 and continues at rapid pace ( about 2500 to 3000 per week)...we have never had a recession when this average was heading down conversely we have
always had a recession when it was heading up....

John said...

At some point the panic in the markets is going to make more businesses cautious on the economy and capital investments will begin to be affected. This will not play well in Washington. There is an election bearing down on the politicians and if our economy is percieved to be rolling over...whether it in fact is or not...will mean even more trouble for incumbents.

To help the situation in the short term we need, most of all clarity on the financial regs. No one knows the new rules going forward. Whatever it is, they need to decide. Next, we need the President to make SOME statement on the positive role Wall Street plays in the overall economy. Many have been bad boys in the last few years but the perception in Washington seems to be that they all need to be taken to the woodshed and thrashed within an inch of their lives...one by one. This is not helpful for economic confidence and certainly isn't going to inspire more hiring. At some point...and we may be approaching it now...the public at large is going to start asking, 'What's going on?' and the President and the ones in the majority in Congress are going to owe them some answers besides 'its those evil bankers up to their tricks again'. Now I do not believe that is what they will say. But they're going to have to say something. They will not fiddle while Rome burns. Expect something soon out of Washington.

One other thought. The Treasury should use this opportunity to shove as much debt out the maturity ladder as they possibly can. They're going to need it.

nobody said...

The yield curve is much flatter today. Banks will be losing their cash cow. The curve averaged around 280 basis for the 1st quarter and banks reported their best quarter, so expect bank profits to fall by 15-20% if the curve continues to flatten. The FED is still on their side though, so they got that going for them, which is nice.

per recession talk, you can't look at leading indicators. How long did they take to signal the last recession? The economy was already cracking and unemployment was climbing by late 2007 early 2008 but it was not a technical recession until late 2008. Continuing claims were climbing during that late 07-early 08 period just as they have the past month. I'm not suggesting that a double dip is on the horizon but I think economists put too much emphasis on slow moving indicators that take at least months of numbers to interpret.

Family Man said...

And EURUSD is raising. Interstingly 1,215 was a very important level for SWF, a water mark (by the way we have a flood wave not seen from 1850 here in Warsaw)of entering into a loss zone in their reserves allocated in EUR.

John said...

Cristian,

I am waiting and watching too. There are terrific values available now but panic makes being early too expensive for large positions.

A VERY good trader I follow has just gone long Goldman Sachs (GS). He is a TRADER and could be out next week (or tomorrow) but he is very long financials and has as good a record as anyone I know. I am slightly underweight the sector but not much.

Like you, still waiting.

Scott Grannis said...

Family Man: there are encouraging signs that currency markets may have gone too far in a number of areas. I note the big reversals in CAD and AUD, and possible signs of a bounce in EUR.

Family Man said...

Scott
There is a good piece on ECRI page.
Their USLLI is still predicting expansion.
http://www.businesscycle.com/news/reports/1806

Copper is flat/up, EURJPY bounced from 110. ECB just started its job of buying 0-5 year European Periphery (EP) debt. Panic is here. So there is quite good setup for the upside, i think.

What worries me is 3bn of EP debt on european banks balance sheet.

John said...

Nobody,

I think bank stock prices are now discounting every bit of a 15% earnings haircut.

Just my cheap opinion.

John said...

Fam,

Re the 3b of debt on euro banks' balance sheets:

They have a bidder in the ECB if they need to sell. Also, the interest payments are being made and the maturities are long on average. In the short term I don't see a problem.

Its confidence that is lacking. I still think this will pass.

nobody said...

John-

after today, they have priced it in.