The Story in four Charts

Four charts shedding light on:

i) Spain 10-year yields heading towards 7%
ii) BRICS are insufficient to hold up the global economy
iii) A coordinated central bank FX swap operation is unlikely at this point
iv) Broad-based deterioration in eurozone macro dynamics

Source of image – Bloomberg

1. Spanish bond yields: It’s different this time
As Spain’s 10-year bond yields hit fresh 6-month highs at 6.70%, the momentum of the current rise suggests further increases ahead, rather than a pause or reversal as was the case in December or August of last year. The fundamentals for Spanish 10-year yields to reach the “bailout territory” of 7.0%, reached by Greece, Portugal and Ireland include further breakdown in talks between Madrid and the ECB and a possible hike in bond margin requirements by exchanges such as LCH.clearnet. But a more vocal catalyst to further gains ahead is the stochastic indicator for the monthly chart, suggesting Spanish bond yields are technically better positioned for further “run-up” (green circle). This is unlike the highs from December and June when stochastics appeared topping out, suggesting “overbought” positioning (red circles). As yields take out the 7% territory, the spread between Spain & German 10-year yields will push further up the 5% level, the same level triggering bailouts for Greece, Ireland and Portugal. Although Italian 10-year yields did near 7% levels and 5% spreads in November, the situation was alleviated by a system-wide LTRO and coordinated central bank liquidity swap, which served as a substitute for 1-nation bailout.

2. Falling BRICS
Brazilian Rates to Hit Record Low Today In another sign confirming that this is not 2011 or 2010 when eurozone market woes would be alleviated by the BRICs, Brazil’s central bank today readies to make its 7th rate cut, taking its selic rate to a record low of 8.50% (from 9.00%) as part of the government’s efforts to call on private lenders to reduce interest rates on various forms of credit/financing for business and individuals. Rates have fallen by 350-bps over the last 10 months in an effort to stimulate the sharp slowdown in growth. GDP q/q hit 0.3% in Q4 2011, from 1.1% in Q4 2011 and 2.8% in Q4 2010. India Easing Moves into Repo Rate Last month’s cut in the Reserve Bank of India’s repo interest rate was the first since 2009. The RBI has already cut its cash reserve ratio requirement (CRR) twice this year, which encourages banks to lend and hold fewer funds. The cut in the repo rate (principal interest), is aimed at driving down the cost of funds across the board. The repo rate was raised 13 times from early 2010 to last October, aiming to fight off stubborn inflation.

3. EU-US LIBOR Spread “Not” due to Rising USD LIBOR
As the spread between euro and USD 3-month LIBOR extends its plunge to 0.13% from 0.70% in January, the resulting decline in the EUR/USD follows through as it has over the last 3 years. The notable difference between today’s selloff and previous phases such as in late last year is that the declining EU-US spread is not a result of rising USD LIBOR but solely a result of declining in EURIBOR. This may reflect the improved liquidity situation among US banks and highlights the euro-centricity of the latest woes. This also helps explain the 3% rebound in US equities from their mid-month lows. One potential implication of such causality to falling EU-US LIBOR spread and stabilizing US LIBOR levels would be the non-likelihood for the Fed to lead a co-ordinated central bank currency swap operations to alleviate USD shortage. This is not the case today.

4. EU Confidence Broad Deterioration
May eurozone Industrial confidence index hit 27-month lows at -11.3 from -9.0, Economic confidence index deteriorated to a 31-month low at 90.6 from 92.8, while Consumer confidence held unchanged at -19.3. The multi-sectoral macro-deterioration is clear and so is the erosion into German shores following recent IFO and ZEW surveys. Chatter of sub 1.0% interest rates by the ECB starts to emerge as CPI enters a new slowdown phase after falling off last year’s 3.0% peak and LTRO remains out of the conversation.