Mr Market, EMU scenarios and credit status
A lot of scenarios have circulated ever since the Greek debt crisis escalated and we got contagion into the Mediterranean periphery. And all these elements were related to bailouts, fiscal consequences of bailouts on core European countries (eg possible eurobonds etc), too big to bail (Spain/Italy) and rescue funds, whether or not the ECB would start the printing press and finally, a breakup. Considering these breakup scenarios, also variations exist : Germany leaving (and potentially some others) with a weaker EMU remaining and some hard currencies reappearing. Or the weaker being forced to leave and have them return to their old currency.
Now concerning these breakup scenarios, it's always interesting to know Mr Market's opinion because Mr Market in the end determines the return of portfolios for each and every one. So what has happened over the past couple of months and more importantly, what seems to be Mr Market's interpretation ? Finally, how has Mr Market valued Germany in this changing debate ?
Especially this last argument deserves some attention. The following table summarizes the period 20/07/12 until now. The reason I choose 20/07 is the fact that at that point, the crisis flared up in all intensity for a couple days starting with Italy and Spain transgressing again their psychological thresholds of respectively 6 and 7% on 10y government bond yields. Briefly, all hands on deck. In between then and now, we had some interesting developments taking place. First of all the warning of Moody's shortly after this event (23/07 and the future uncertainty of Germany and core Europe). This warning contained 2 elements, being a bigger burden to shoulder for the richer countries and the danger of a partial or entire breakup for European and global financial stability, also having an impact on the richer countries and their credit status. Then came the ECB preparing for a game changer and politics moving into the direction of going all in (ECB buy programs - ESM) with Germany seemingly willing to go all the way as well (see also Jorg Asmussen within the ECB changing tactics). Now how have things evolved as far as Mr Market's perception is concerned ?
Note : yellow means up while blue means down compared to 20/07 ; the shades of the color reflect the intensity of the movement.
First of all, core European yields went up. This could be a reversal of risk, the Moodys' comment on burden sharing having an impact on the core budgets, or a combination of both. The most interesting part however is the CDS or credit default swap evolution where it is clear that for all nations - Germany included - the CDS improved or the risk premium in basis points went down, this after the recent political developments took place. Now this is interesting : German yields going up and CDS going down, what is going on here ? Or, the future budgetary cost for Germany expected to increase while simultaneously its credit status as perceived by the market improves. Hhhmmmm. It seems to me that this could mean a thing or two and it basically involves risk and uncertainty. And it also reflects a part of the Moodys' statement on 23/07, with the fear for the unknown (uncertainty) coming up front. It probably means that for Mr Market, "cholera/plague" - being going "all in" in order to preserve the current EMU construction - is to be preferred to - for the sake of the metaphore - an "unknown disease". Because the "unknown disease" following an EMU implosion or breakup implies collateral damage hard to calculate, with an impact not only in Frankfurt but going from Tokyo all the way to Bejing, London and NY.
Now I always could be wrong about my interpretation about Mr Market's sentiments about these scenarios. If so, always feel free to join the blog debate.