Friday, June 4, 2010

Now France

Peter Boone and Simon Johnson write:
The big news is France. With sentiment worsening across Europe, France has lost its relative safe haven status – credit default swap spreads on French government debt were up sharply today.

The trigger – oddly enough – was Hungary’s announcement that its budget is worse than expected...

It did not help that the Irish Minister of Finance announced Ireland has 74.2bn euros of guaranteed bank loans, bonds, and systemic support falling due between now and Oct 1. This is around 55% of GNP...

The big losers are Portugal-Ireland-Italy-Greece-and-Spain as always, but Belgium is now in the line of fire, and France is clearly under pressure. The spread between French and German credit default swaps (measuring the relative probability of default) is up – yesterday this was 40 basis points, today it stands at 44 (up from just 5 basis points at the end of 2009; most of the increase is since mid-March, with a sharp acceleration recently). French bonds have become illiquid, with wide bid-ask spreads; not what is supposed to happen in a safe haven. This is going to make the French angry – watch for more market slanders from top French politicians over the weekend; you know they would just love to ban trading in something...

This has the potential to become a run on most non-German bonds in the euro zone. Next we will see pension funds and reserve managers stepping back and waiting to see what happens – there is no profit in buying French bonds for a 40 basis point spread over Germany given the risks and illiquidity that we have seen in other markets...

 And if the ECB announces it will buy French bonds, investors will probably step further back and just let them buy. We are beyond the point where mere expressions of intent-to-support will lead to a private sector rally.

Investors increasingly fear that it is simply unsustainable – economically and politically – for the ECB to support the rollover of public and private debts. If investors – acting on this belief – refuse to rollover bonds, the entire policy disintegrates into uncontrolled money issue.
Boone and Johnson are spot on with their analysis up to here. However, they then write:
Quantitative Easing on this basis will fail.
There is a slight implication here that ECB is akready conducting QE, however, as we have pointed out, any money injected into the system by the ECB is being sterilized with equal size money drains.

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