IF WHAT HAPPENED in the European bond markets on Tuesday last week had happened in the equity markets, every newspaper in the world would be headlined 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 that 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 was blown away. From trading at 93bp over Bunds on October 27, the benchmark OAT was priced on Thursday at 200bp over, although it did begin to find support by the close. By Friday afternoon there had been a bit of a bounce back into the 170bp area but the basic statement of sentiment can’t be hidden.
Forget all the nonsense you read about whether the debt of La Grande Nation is being priced as Triple A or not; that has become a fatuous and empty discussion. 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 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. 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.
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
Last week 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 received a note from a forex chum on Wall Street asking whether the euro/dollar would 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, the Netherlands, Luxembourg and maybe Finland; Austria at a pinch too – then the currency that 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.
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 on Tuesday was the way 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 weeks until Christmas?