Tracking the Many Headed Euro Sovereign Debt Crisis Monster

Posted On: Monday, January 23, 2012

In a day dominated by headlines from Europe, it seems like a useful excercise to summarize some of the key points of where we are now, and dates to watch for.  To begin with, despite the bailout packages granted to the PIG, Portugal, Ireland, and Greece, the basic insolvency problem remains unsolved.  What each of these packages has done is provide additional liquidity to what many argure are countries in need of debt restructuring. 

1.  Greece and Private Creditors - Day by Day

Currently Greece and its private creditors are at the crossroads.  The second Greek bailout package envisioned a debt haircut of 50%, but this has been increased to at least 60%.  However, even if and when this is agreed to, Greek debt-to-GDP is still expected to be around 120%.  With Greece's economy in a downward spiral, and budget deficit forecast to top 10% in 2012, few believe that even a best case scenario where private creditors accept a 60% writedown will create a solvent Greece.   

Negotitations between Greece and private creditors have been dragging on weeks.  There does seem to be some more urgency in recent headlines as a looming March 20th bond payment will likely result in default without an agreement. 

Expect this aspect of the Euro Crisis to remain a flash point in the days ahead.

For those that wish to get a better feel of the complexity involved in the current negotiations, and why many feel that an eventual deal could spell massive unintended consequences for the sovereign bond market, read Zerohedge's Subordination 101:  A Walk Thru For Sovereign Bond Markets in a Post-Greek Default World.  Be sure you have a spare hour if you want to read the whole analysis.

2.  The Second LTRO - ECB Set to Pour Hundreds of Billions More into Euro Banks

It can now be said that the ECB's Long Term Refinancing Operation (LTRO) has provided much needed liquidity to European banks who were fearful of lending to each other, and at risk of having a massive liquidity crisis as they sought to roll-over hundreds of billions of EUR in borrowing.  A total 489 billion EUR of funds were taken up by Euro banks, nearly double the estimate ahead of the operation. 

While the initial reaction could be described at "shock" at the sheer scale of demand, in the end, the EUR-USD has voted, and is now again above the 1.30 level, having fallen below 1.27 in the days immediately following the the first LTRO.

Now, markets are eagerly anticipating the second round of LTRO, and expectations this time around range from 600 billion EUR to 1 trillion EUR.  While the ECB may not be directly financing EUR area governments, by providing this massive amount of lending to the area's banks, there is no doubt that some of these funds are slopping over.  Indeed, since the LTRO has a 3 year term, there has been a notable reduction in similar maturity sovereign bond yields. 

The next LTRO operation is due to begin on February 29th.  Expect the global financial system to salivate ahead of this next round of cheap and abundant money from the ECB.

Commodity Rallies - Gold and Silver Basking in the Money Printing

Despite the Greek troubles, gold and silver have moved with most commodities to the upside.  It seems reasonable to assumet that at some point, and despite the clear danger from Europe's bigger basket cases, massive injections of liquidity will have a positve impact on all prices.  The LTRO is indeed a massive injection of liquidity.  In this case, silver has had a massive start to 2012, rising 20%, and 8% just in the last week.  Gold prices are up a more modest 7% YTD, but this represents nearly 100 dollars.  With the second LTRO just a month away, furhter upside from a global financial system awash in what will be at least an additional 1 trillion in EUR from both LTROs, would not be completely suprising.     

Precious metal investors should keep an eye on the ongoing developments in Europe, particularly Greece, Portugal, and Italy.  The upcoming LTRO is certainly the biggest event on the horizon, barring a messy end to the current Greek negotiations with private creditors.

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