Back in the EU Debt black hole’s event horizon

Here we go again, Spain’s regions ask for help from central government and we’ve got a new aggravation of the EU debt crisis which will need yet another massive response from authorities.

We’re back within the event horizon now of a full blown EU crisis, as the multitude of Spanish regions’ request for central government aid pushed Spanish sovereign yields to new record highs for the cycle – to as high as 7.5% for the 10-year benchmark. Italian yields were also higher. As well, today we have a Troika contingent descending on Athens for a progress report – and the assessment there may very well set the stage for an eventual Greek exit if Athens has failed to change its ways. The rhetoric from the EU side has certainly been much sharper of late, with two Germany quotes in the media very critical of Greece and even the EU commission.

I was traveling in Russia all of last week, and I heartily thank my hosts and the attendees of the various seminars, interviews and dinners who listened to my presentation of our outlook for the coming quarter and beyond. The level of interest and engagement in dialogue was on a level I have never seen before, whether in Russia itself or other countries I have visited in recent years. It’s amazing how quickly the discussion moves from specific topics to the profound level of uncertainty on what the longer term future looks like, particularly for the EU – it’s pretty clear that none of us really understand what an eventual solution will really look like – we can only paint the rough outlines and reassure ourselves that the status quo is on the way out.

Speaking of the status quo, before last Friday, I was struggling a bit to describe the market’s thinking “at the moment” as the Euro remained extremely weak across the board on continued EU worries, but risk appetite was doing rather well. The weak explanation was “the Euro carry trade”. My basic comment was that the EU carry trade idea has validity up to a point, but that the general complacency was unjustified given the global uncertainties of the moment and that the very dangerous thinking that the market was engaging in at the moment was the idea that the central banks have essentially outlawed volatility.

Here’s my tweet from 6:00 in the morning on Friday (you can follow me @johnjhardy):

This market crazy – saying that volatility will never be allowed by CB’s, so why not just buy risk despite backdrop? I’m not so sure…

IT would appear the last couple of days are showing that this thinking was indeed dangerous and now that the cat volatility is out of the bag, it may be on the prowl for a while.

Chart: AUDJPY
The biggest shock over the last few days has been administered to the pro-cyclical/JPY crosses, as a cross like AUDJPY shows below, as the neckline-ish area is looking a bit broken after today’s action. The question going forward is whether in an environment of risk aversion, some deleveraging might set in due to the volatility, in which case the extremes in EURAUD short position could be squeezed very hard. Stay tuned.

In the something different department today, we have China’s Cnooc buying Canada’s . That’s enough M&A to move CAD more than a bit in the crosses, assuming the deal is not rejected by the Canadian government somewhere down the line (this one is more likely to go through than the Potash deal that was rejected some years back). In that light, one wonders if AUDCAD has now topped after its magical ascension to a spectacularly overvalued 1.0500.

Looking ahead
Tomorrow is global “flash PMI day” as we have the HSBC survey for Chinese manufacturing for July out tonight and both preliminary services and manufacturing surveys out for Germany and the Euro Zone tomorrow. It will be interesting to see if there are signs of stabilization or a further deceleration.

The next big hopes on the QE horizon are the August 1 regular FOMC meeting followed by the minutes of that meeting three weeks later and then the Jackson Hole, Wyoming conference held at the end of the month, to see what new exotic forms of gravy the Fed my whip up for us if it proves that the US is indeed tipping into recession and again, just before a lame duck and uncooperative US Congress and possible lame duck president may fail to soften the drop off the Fiscal cliff come January 1.

But first things first: if a lid is not put on this EU debt crisis in the interim, any efforts from the Fed are going to end up being exclusively about damage control and putting a bottom on the panic rather than any fantasies about a recovery or an extension of the risk rally. The stakes are high once again, especially as we have just touched a multi-year low in FX volatility last week – the irony is that big moves sometimes must be preceded by extreme complacency as the latter can act as a kind of store of energy for the subsequent move.

In that light, stay careful out there as always.

Economic Data Highlights

• US Jun. Chicago National Activity Index out at -0.15 vs. -0.48 in May

Upcoming Economic Calendar Highlights (all times GMT)

• Euro Zone Jul. Consumer Confidence (1400)
• China Jun. Leading Index (0200)
• China Jul. HSBC Flash Manufacturing (0230)