Anthony Peters, SwissInvest Strategist
If what happened in the European bond markets on Tuesday had happened in the equity markets, every newspaper in the world would be headlining with “Meltdown!” accompanied by pictures of chaps sitting in front of screens with their heads in their hands and telephone numbers of figures as to how much value had been wiped off the market cap of the principal indices. Instead all we get is “Eurozone in Crisis” which ranks along with “England grind out narrow win at Wembley” in the journos’ book of old chestnuts.
In fact, it was one of the worst days I can remember in markets as everything which wasn’t German crashed. I had been focusing on Spain as the silent killer but it was what happened to France that will have investors quaking in their shoes.
The OAT market effectively got blown away. From trading at 93bp over Bunds on October 27, the benchmark OAT priced yesterday at 189bp over and still felt offered on the close. Forget all the nonsense you read about whether the debt of La Grande Nation is being priced as a AAA/Aaa or not; that has become a fatuous and empty discussion at the hands of a bunch of journos who either haven’t got a clue what’s going on or who have been told that X or Y is for the political correspondent to write about and not a subject for the business pages.
The two pillars of the eurozone
The eurozone is supported by two pillars, one with the money and the other with the political will – no prize for guessing which is which. I have spent a long time expounding the theory that as France was not permitted to impose a second Treaty of Versailles upon the defeated Germany in 1945, it got its own back through the Coal and Steel Union and the Common Agricultural Policy which together made up the EEC Treaty and which were, in effect, nothing more than a well disguised pipeline for pumping cash from Bonn to Paris and served to subsidise superannuated French heavy industry and farming practices.
The Marshall Plan rebuilt Germany and the benefits thereof rebuilt France – hence President Charles de Gaulle’s fierce opposition to Britain joining the Union – no way was he going to share all that lovely Boche cash with perfidious Albion. Alas, Germany and France have played at being twins but in reality were no more alike than Arnold Schwarzenegger and Danny DeVito.
In the same way in which rates and credit markets alike accepted blindly that Greece was kind of OK so long as it was part of the grand European project, so it had also been taken as written that Germany and France are equal partners joined at the hip. In reality we all knew that there were huge differences, but it is an old wisdom that if you repeat the same untruth often enough, it will eventually be perceived to be a truth, irrespective. I have a chum in Paris, a former government bond trader, who has been predicting that France would fall sooner or later – and fall hard – who has forever been castigating me, the sceptic in chief, for being too optimistic.
Yesterday saw the inalienable link between France and Germany broken and with that the Union is now standing on one leg. All the while, the euro was weakening and I got a note from a forex chum on Wall Street asking what we all thought – would euro/dollar be higher or lower come the end of the year. It is a difficult call. If the weaker members were to drop out and the best were to remain together – Germany, Holland, Luxembourg and maybe Finland; Austria at a pinch too – then the currency which would stay behind would be hugely strong. Call it euro or call it mark, it would be rock solid.
Hence, a switch from a Spanish or Italian or even a French bond into a Bund or something similarly German is not only a statement of credit quality, it is contingent forex forward trade too; it is buying a call option on the Deutsche mark. Forget the 200bp or 300bp or 500bp give-up – think of the 40% currency gain you take if the currency union cracks. In the mood in which markets are at the moment, it is an option very few feel that they cannot afford to buy.
There is no doubt in my mind that markets are absolutely terrified of what they are seeing when they look at themselves in the mirror, but from the perspective of individual investment managers, it’s not a question of right or wrong, it’s a question of running in whatever direction the markets are going and of being seen to have done everything reasonably possible to preserve their clients’ cash.
There is no doubt in my mind that markets are absolutely terrified of what they see when they look at themselves in the mirror
The “risk on” merchants appear to have failed to read the runes as we have watched the world and his wife taking advantage of every technical rally to reduce risk. What changed yesterday was the way in which investors were more than happy to sell further into a falling market. I saw someone make the rather pertinent observation that liquidity had gone negative – you could only buy what you didn’t want and sell what you didn’t have. No fun at all – is it really still five and half weeks until Christmas? OMG!