Careful With That Beehive, Eugene

August 14, 2012

Some profit-taking and easing back of the risk trade. Spreads, equity runs and CDS spreads have all done well. There does not appear to be a lot of room to advance in the short term.
-Christian Thwaites, president & CEO, Sentinel Asset Management

When you move a beehive, you must move it more than three miles or not less than three feet. Anything else confuses the bees. Markets can be the same. And that's why President Draghi's comments reverberate still after two weeks. No one seems to understand what he meant. It seems open market operations are within the ECB's mandate and do not violate the principle of monetary financing if there is high convertibility risk. That last part means redenomination risk, especially of the troubled peripherals, and is termed the risk premia. But the only way to reduce the premia would be direct purchases to lower Spain and Italy's cost of borrowing. The market hopes the ECB will follow through which is why European equities rallied some 10% these last two weeks.

That seems decidedly thin gruel. There are 23 members of the ECB Governing Council, six executives and 17 representatives from the national central banks. Germany, which is liable for around 30% of the ECB's risks, has the same voting power as the Governor of the Bank of Malta. Germany remains implacable to any program which might cause inflation and is convinced that any bond buying does exactly that. This week Bundesbank President Jens Weidmann said "Financial assistance must remain a last resort" which, even after applying the well-known Teutonic smiles and sunshine (HT Mr. Burns), sounds pretty definite. So investors expecting follow through from the ECB are likely to be disappointed. It's more likely that the new found risk appetite will wane quickly.

Things are grim in the real economy, too.


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