The Eurocrisis has reached a new, dangerous stage:
“With no immediate threat of inflation and slow economic growth in Europe, investors don’t need to be as worried about a big surge in yields,” he (John Sajdak) says.
Investment advisors have seemingly short memories. Last summer, the Eurozone was on the verge of collapse due to a periphery recession caused by an ill-fitting currency union. Today, the recession continues, but this is interpreted as bullish for PIIGS bonds in the quote above.
Default risk and breakup risk still exist for peripheral bonds despite the article’s failure to mention them. Moreover, Spanish and Italian bonds have converged with German bunds so a further rally based on shrinking spreads is unlikely. Before you buy those PIIGS bonds, ask your broker how much he owns.
Spanish NPL’s continue their inexorable march upward. As long as Spain’s property market deteriorates, NPL ratios will rise. The rate recently topped 11.6% in June, and this number underestimates the true number of NPLs. Moving some of the bad loans into SAREB excludes them from the final ratio. According to this article,
bad loans are actually about 17% of total outstanding. This figure represents 25% of Spanish GDP.
India is seemingly caught between the proverbial rock and a hard place. The RBI can either let the rupee bleed eventually resulting in a financial crisis, or it can raise interest rates to staunch the currency probably causing a deep recession. In the former case, the financial crisis will surely cause a recession anyway, so I would choose to raise rates. Paul Volcker’s Fed faced a similar choice in the early 80’s. A deep recession choked off inflation and caused a deep recession, which was followed by an eight year expansion.
The mainstream media is treating the emerging market swoon as a recent event, but these markets (as represented by EEM above) began diverging from the US last summer. Draghi’s pledge was successful in arresting the capital flight from the periphery. It seems that this money was redirected from emerging markets to Europe. Note that the European Stoxx 50 index tracks the SPX nicely in the chart above while the emerging markets have found their own path down.
The PBOC’s head is confident joining a long list of confident central bank heads. It’s their job to exude confidence, so we’ll let them. In the meantime, we’ll examine the numbers. Chinese liquidity has yet to return to pre-crisis levels with the overnight repo rate stuck at 4%. Additionally, Chinese government bonds rates have been rising:
Money is slowly leaving the Chinese financial system. Unlike India’s RBI, the PBOC seems to be on top of the situation providing enough liquidity to maintain the health of the Chinese financial system. Only time will tell if its efforts will continue to be successful.