Don’t tell anyone on Wall Street, but Europe’s financial system is starting to implode. From Doug Noland at creditbubblebulletin.blogspot.com:
Seven UK mutual funds thus far have halted withdrawals and/or taken significant write-downs on fund asset values. Combined fund assets are about 20 billion pounds. Back in June 2007, it was the implosion of funds managed by Bear Stearns with about $20 billion of assets that set in motion the collapse of the mortgage finance Bubble. To be sure, bursting Bubble dislocations would have been less destructive had “Terminal Phase” excess not run roughshod throughout 2007 and well into 2008.
When I criticized the Fed’s reflationary policies back in 2009 – and initially warned of the emergence of the “global government finance Bubble” – the focus of my concerns was not hyperinflation or a dollar collapse. My worry was the likelihood for massive global fiscal and monetary stimulus to foster a systemic mispricing of “finance” – securities prices and Credit more generally. From this global macro perspective, the outcome has been my worst-case-scenario. Actually, policy measures and attendant pricing distortions have been far more extreme than I could have imagined.
Japanese 10-year JGB yields ended the week at negative 0.29%. German 10-year bund yields closed the week at a record low negative 0.19%, and Swiss yields were a record low negative 0.69%. French 10-year yields ended Friday’s session at an all-time low 10 bps. The Netherlands saw yields drop to zero. U.K. gilt yields sank 10 bps to a record low 0.73%. And despite stronger-than-expected job gains, Treasury yields closed the week at a record low 1.36%.
Italy, with three Trillion of sovereign debt measured at a problematic 135% of GDP (and growing), ended the week with 10-year yields at a record low 1.19%. Mario Draghi’s “whatever it takes” has had a most profound impact on Italian yields (down about 500bps since the summer of 2012). Yet despite collapsing borrowing costs, Italy nonetheless runs persistent budget deficits. And while the ECB has thus far succeeded in keeping Italy solvent, the same cannot necessarily be said for Italy’s troubled banking industry (see “Italy Watch” below).
From the Wall Street Journal (Giovanni Legorano): “In Italy, 17% of banks’ loans are sour. That is nearly 10 times the level in the U.S., where, even at the worst of the 2008-09 financial crisis, it was only 5%. Among publicly traded banks in the eurozone, Italian lenders account for nearly half of total bad loans.”
In a more normal market backdrop, Italy’s finances would today be in crisis. Surging sovereign yields and failing banks would have forced harsh but needed financial, fiscal and economic structural reform. This should have transpired years ago. These days there is perhaps some tension, but there’s no burning crisis in Rome. Prime Minister Renzi, while politically weakened at home, can use his government’s vulnerability to wield impressive power in Brussels and Frankfurt, especially post Brexit. After all, Italy could rather easily bring down the European banking system. Indeed, the Italians today hold sway over the euro currency, and Renzi knows he’s playing a strong hand.
July 6 – Reuters (Isla Binnie): “The difficulties facing Italian banks over their bad loans are miniscule by comparison with the problems some European banks face over their derivatives, Italian Prime Minister Matteo Renzi said… Speaking at a joint news conference with Swedish Prime Minister Stefan Lofven, Renzi said other European banks had much bigger problems than their Italian counterparts. ‘If this non-performing loan problem is worth one, the question of derivatives at other banks, at big banks, is worth one hundred. This is the ratio: one to one hundred,’ Renzi said.”
To continue reading: Sovereign Market Dislocation and Derivatives Turmoil
