Europe's First Casualty?

While not quite the scale of Lehman Brothers, this may be the first of a new round of 2008 like banking failure.

Earlier tonight I was watching the only thing that seems to matter to short term trade, the EUR/USD.

I saw this move up, which seemed quite extreme at the time. Apparently the consortium representing European banks in the 50% bondholder haircut said that 9 of 10 banks were likely to accept the terms, causing this spike. That was the knee jerk reaction to headlines, but the larger picture is this. With the banks taking 50% losses on Greek debt holdings and without the protection of CDS to insure against those losses, the banks will immediately have a problem that would likely result in them having to sell the underlying assets, namely Greek and other PIIGS  bonds, once again driving yields up (unintended consequences). I went to look at a few charts for 5 minutes or so and saw a truly extreme move to the downside. This is somewhat reminiscent of 2008 when unintended or unforeseen consequences an pop up instantaneously and change everything in a blink of an eye.

Apparently the catalyst for the sudden risk off trade was a possible conclusion to the recent ongoing trouble faced by MF Global, which is a New York based Broker/Clearing House for commodities as well as market based futures and derivatives, but last year John Corzine took over control and tried to turn MF in to more of an investment bank. They bet heavily on European sovereign debt. They are now taking heavy losses on those bets and seems to be one of the first financial institutions being taken down by the European crisis. They've been in talks for various kinds of deals from mergers to buyouts all weekend long, but potential buyers, much like Lehaman's subprime portfolio, are finding it difficult to assess the value or the losses associated with the European losses. The instant turnaround in the EUR came as Dow Jones wire service announced that US Clearing Houses and Regulators should prepare for an imminent bankruptcy as this weekend has failed to secure any deals that may saveMF from that eventuality.

While MF is a significant player, not as big as CME/ICE, I don't think the panic is over MF itself as much as it is over the nature of how quickly losses in European sovereign debt can materialize, more or less echos of the 2008 Bear Stearns/Lehman era. 

The Euro just took out the support lows from Friday.

As I've been writing this, the Euro has fallen further, about 120 pips in the last hour alone.

As of this moment, the EUR has taken out the Thursday Oct. 27th opening of $1.4138 as it now trades at $1.4040.

ES action is a little more muted, but very lose to taking out Friday's lows.

And The Euro Opens Lower

I guess it's not too surprising given there's a $550 billion dollar gap in the EU donation box and seemingly no serious contributors on the horizon.

There are a lot of dynamics in play this week from the G20 to the FOMC. There's also a large Euro short position in place.

As far as the G-20, I don't expect much to come out in the form of Europe's problems, it's just not on the Agenda.

As for the FOMC, I am starting to think that QE3 will be announced at some point if for no other reason, the fact that everyone is selling US Treasuries to recapitalize banks, so new buyers need to be found which is unlikely, which means the "FAD" will at some point likely have to step in in another POMO operation. As far as timing, I don't think they can possibly do anything this soon. There are several reasons, first they haven't given operation twist enough time to work and announcing QE 3 would be admitting OT was a failure. Secondly, Q3 GDP just came in a bit better then expected, the FAD needs political cover to launch QE3 and with GDP better then expected, it will be hard to explain.  Lastly, there's so much anti-Fad sentiment right now, they need Congress to practically beg them to launch QE3, which means they again need political cover and probably in the form of a major market sell-off. Lets not forget the last two meetings in which the "FAD" has essentially told Congress, "You need to clean up your spending mess, there's not much we can do until you do". I don't think they'll want to let Congress off the hook so soon, especially before the "Super Committee" weighs in with their cost cutting suggestions. So QE3 a possibility out of need to sell treasuries? Probably. Soon? Probably not.

As for EUR Short interest, the first thing traders think of when they hear "high short interest" is "Short Squeeze", however FX markets are totally different then stock markets, where profits are measured in pips or moves of .0001%. There is huge leverage and these are smart players, not the typical dumb money found in equities. When major institutions smell blood in the water, the short interest jumps and for good reason and it's not followed by a short squeeze, just ask Lehman and a lot of other institutions that have been brought down by the shorts because there were real fundamental problems in place. This is a different type of investor sophistication and I believe they smell blood in the waters off Europe so I wouldn't be so quick to be looking for a short squeeze.

Wednesday is the FOMC, Thursday and Friday is the G-20. There's the possibility for a volatile week, there's also the possibility for extreme disappointment.

Oh My, How Fast We Turn Nasty When We Don't Get What We Want

As you may have heard, it looks like China is not going to be Europe's Savior. 


I read earlier today that the EU's, EFSF "Grand Plan" was, "An empty box filled with promises of money" which captures the spirit a lot better then my pointing out that this is a "plan" not an action.


The Europeans, so desperate to fill their empty box with Chinese money, even tried to "Tempt China with bonds issued in Yuan".


China's response, 

China’s state media says their cash-rich country won’t save Europe

The official Xinhua news agency said Europe must address its own financial woes. “China can neither take up the role as a savior to the Europeans, nor provide a ‘cure’ for the European malaise. “Obviously, it is up to the European countries themselves to tackle their financial problems,”

Another Chinese official has played down hopes of a breakthrough at the G20 meeting. Vice Finance Minister Zhu Guangyao, also speaking Friday, said investment in the European bailout fund was not on the agenda.

For its part, G20 partners will also be looking to China to stimulate domestic demand, diversify its export-led economic model and allow the yuan currency to appreciate more freely so as to slim down its massive trade surpluses.

Beijing fears the financial risk of a major investment, which could also spark a domestic backlash as the Chinese public asks why they should bail out wealthier nations. Already, opposition to such a move is being expressed on the Internet, on China’s hugely popular weibos - microblogging sites similar to Twitter - and in state media.

I've mentioned before, China is very sensitive to anything that will cause civil disorder.

So... Europe quickly shifts gears and sends the G-20 a letter, hoping the G-20 will fill their empty box of promises.

The Full Text of the Letter Can Be Found Here

I just want to touch on some interesting parts.

After 5 bullet points telling the G-20 what they have done with their new plan, they follow up with this...

"We will implement these measures rigorously and in a timely manner, and we are confident that they will contribute to the swift resolution of the crisis. However, whilst we in Europe will play our part, this cannot alone ensure global recovery and rebalanced growth. There is a continued need for joint action by all G20 partners in a spirit of common responsibility and common purpose."

The letter then goes on to define 8 priorities the G20 should focus on, only days ahead of the meeting.

In the first set of priorities they mention the following,

"The EU's main contribution to Cannes is the above-mentioned packageto ensure the stability of the euro area. But more needs to be done at the global level. Many of the distortions underlying the large pre-crisis imbalances are still to be addressed – including undervalued exchange rates in key emerging surplus economies, and insufficient domestic savings in some advanced economies. "

One of the conditions the Chinese were likely to seek in exchange for bailout money was that Europe drop it's complaining, along with many other countries, most notably the US, about the manipulated Chinese currency. In bold, they were clearly taking China to task. In the last half, they were taking America to task as a report this week showed American savings at the lowest rate in years.

You may recall Tiny Tim G. was against allowing money from the IMF (Read American controlled institution) to be used to help shore up Europe and how quickly the Europeans turned on China's most delicate soft underbelly-the issue of their "manipulated currency". There could be few others this would apply to.

Further targeting the US and IMF, they continue,

"we also need to continue to ensure sufficient resources for the International Monetary Fund to address crisis situations in a coordinated and comprehensive manner"

In the second set of priorities, they go after China again in the second sentence...

 "Our internationally agreed financial market reforms must be implemented in full while ensuring a level playing field among all G20 partners"

Clearly touching on the Chinese Currency manipulation again.

They then carry on in an ironic twist considering the German discovery of $55 billion EUR through an accounting error.

"and quickly move towards a single set of high quality globally accepted accounting standards."

A little strange for the pot to call the kettle black 2 days after this monumental blunder out of Germany.

I would guess as China's actual economy is so opaque and manipulated, this final condition of paragraph 2 was also aimed at them.

"At Cannes we should also make a clear commitment in support of the Global Forum's work on non-cooperative jurisdictions. The European Commission has recently presented a legislative proposal for a financial transaction tax in the EU. The introduction of a global financial transaction tax should be explored and developed further."

In the 3rd set of priorities, it seems they may be fishing for a new lender in the form of the "R" in "BRICS" countries, Russia. After all, China did make clear that they would not look favorably at acting alone without the other BRICS nations, of which Brazil already declined.

"Cannes should also send a strong message to the WTO December Ministerial to finalise Russia's WTO accession by the end of this year."

This is VERY interesting. I've thought a lot about Russia in this situation and I see a potential longer view plan from Russia as Vladimir Putin will return to the Presidency and make no mistake, he is not about the failed democracy experiment in Russia after the Soviet Union fell, he's an old time hardliner-a Leopard doesn't change its spots. Over the last 15 years or so, both the EU and Nato have made significant incursions in to the former Soviet satellite states. Latvia joining the EU and Nato was a huge embarrassment to former Russian national pride. Putin may see this EU problem as a huge opportunity so why bailout Europe?

Ultimately with the G20 agenda already in place, the letter seemed like first a cry for help, followed by their ideas for the G-20, almost as if the 8 bullet points after their cry for help were a thinly veiled attempt to make it seem like they were trying to contribute to an event that already has an agenda, the whole thing wreaks of humiliation, not to mention some childish reprisals which may come back to haunt them, but like everything else this week from Europe, it seems there's a lot of emotional reaction and not a lot of real thought going in to the problems.