Note: Apologies for the lack of posts. It is holiday season and I have been taking some time of from the blog. But that does not mean posts will stop completely. Lets have a look at the European credit situation.
European bureaucrats recently left for end of year holidays, leaving the financial markets in turmoil during Christmas and New Year period. Credit markets are not improving at all, as funding for US Dollars becomes more and more expensive. This is creating a bid for the US Dollar on the market as well, as the Euro falls back below $1.30 once again. Lets have a look at the health of the credit markets right now:
Libor rates are a great measure of banks’ reluctance to lend to one another. The 3 month Euribor-OIS spread, the difference between the borrowing benchmark and overnight index swaps, is once again approaching 100 basis points. That is the highest level since January 2009. The US counterpart measure, 3 month Libor-OIS spread, is also rising steadily but nowhere as high as the European benchmark. In other words there is contagion, but it is not as bad in the US as it is in Europe.
The cost for European banks to borrow in dollars over 12 months (1 year) continues to rise, according to the 1 Yr Euro Dollar Swap Rate. The current reading is once again approaching over 100 basis points, which is no approaching panic type levels of 2008 Lehman Brothers crisis. The rate was 106.5 basis points under Euribor in middle of December, the most expensive since December 2008. Earlier this year, the bank rate for Dollar funding was at 49 basis points.
Swap rates for two main currencies are increasing for the banks, as already discussed above. While the 2 year US Swap Rate has increased to the levels last since during the "flash crash" panic of May 2010, the EU Swap Rate over the same time maturity has now increased to the levels not seen since the depths of the Lehman Crisis in October 2008. it is very clear that European banks are suffering.
This can also been seen by following increment in deposited capital in the overnight deposits facility at the European Central Bank. Depositors placed 347 billion euros ($452 billion) just recently, which is the most since June 2010. If you remember this date, you would also remember that negative sentiment become so extreme, it created a Euro bottom around $1.18 (last chart below).
Finally, Italian Government Bond Yields remain elevated at previous watershed highs, where other peripheral nations like Greece, Ireland and Portugal were forced to seek bailouts. This is despite a decently strong auction last night as the media pointed out. However, who is actually buying Italian debt? Real investors cashing yield or ECB? Italy auctions more bonds tonight, and I have a feeling the ECB will be the one and only buyer.
I guess it is quite obvious that the credit markets are very stressed at present. Banks to not trust each other so they keep using ECB facilities to survive through this turmoil, the US Dollar demand is very high and the cost of funding is even higher, while governments in Europe are struggling to fund themselves at respectable interest rates. All in all, it is not a pretty picture and reminds us of 2008.
However, we cannot pretend that the market has not already factored this in to a certain degree or at least knows the problems a lot better than what I wrote about here. Therefore, we can see that, accordingly majority of investors are extremely bearish on the Euro (record high short position) expecting a repeat of Lehman Crisis with a bank in Europe. In other words, this is the most overcrowded and super-obvious trade right now - and those never make you money unless you trade the intra day movements.
So what are the chances of Lehman Brothers 2.0 as everyone keeps saying? Well... it is definitely possible, but in my humble opinion, not very probable as of right now. Quite to the contrary to what majority believe, I have a feeling that EU, ECB, IMF and the rest of the clowns could announce some type of measures to kick the can down the road once again. It would calm the credit markets from extreme levels and in the same time force a super short squeeze in risk assets including the Euro. Put it this way... unless you are 100% sure Europe is about to fall apart today, I'd strongly advise against shorting Euros, buying Dollars or Treasury Bonds right here!