Article / 21 November 2012 at 9:11 GMT

EU tail risk is political; Europe's downside risk grows

Chief Economist & CIO / Saxo Bank
Denmark

I'm surprised at the delay in disbursement of the Greek aid. Sure we knew that the IMF and EU disagree on the sustainability of Greek debt, but delaying the final decision to next week means one of two things:

1) This is a real impasse – the IMF defending the need for OSI (official sector involvement – i.e., restructuring debt held by public sector/ECB) to get Greece back on the road - and EU/Germany/ECB not wanting to open the door to further “real losses'' on their domestic deficits from the same exercise. The likely options still may be along the lines of an “OSI Lite” with lower rates for Greece combined with long duration on loans. This will be sold as a quid pro quo for Greece 'compliance'.

2) The policy makers realize they need to go beyond the expected and in doing so have bigger ambition to hammer out a real deal, which is taking a longer time to agree.

The latter could include a compromise on this idea that the year 2020 and 120% to GDP are some kind of magic number, in other words, a real debt forgiveness that stops the nonsense of arguing over pennies (which, for the EU, it is. Greece can’t make a go of it at any level above 90 per cent/GDP). There is also the need to address an almost alarming fall in core European export volumes - that data shows that all of Europe is increasingly in the same boat. Finally, there is the all-critical situation in Spain, as the Spanish region of Catalonia goes to the polls this weekend to vote on independence.

Clearly, Merkel and Germany want both the Greek issue, but also the ever present need for Spanish recapitalization, to go away as soon as possible. But they won’t, and the situation will only get worse before it gets better, as we also have an Italian election on the way, most likely in March.

Yes, tail-risk is back, but this time in the form of political risks. The financial “systemic” side of things remains contained by the ECB put - but the focus is now, rightly, back on the politicians and their lack of willingness to be accountable and proactive.

The EU political leadership has merely been reactive at best, and the deterioration of political consensus is increasing uncertainty in light of the dramatic worsening of fundamentals at the EU core. The response will be tough talk, rising social tensions, and the risk of serious radicalisation at the political fringes. In markets, this will translate to less faith in core bond markets, a falling Euro currency and less transparent outlook, which will hurt equities.

Up to now, EU politicians have been bailed out by the ECB, now the ball is in their court. Of course, the most likely outcome is more extend-and-pretend, but note that social tensions and rising political tail-risk might soon kick off a move toward the phase of crisis I call a “mandate for change” as the unbearable tensions in the situation finally forces a change of behaviour and dramatic new action from the political leadership .

Investment ideas:

Selling CAC-40 CFD and French OATS CFD with 2 pct stop loss.

Safe travels,

Steen

2y
benlouro benlouro
how can be explained the divergence (relative value) between US equities (SP500) and EU equities (Dax or CAC) after US elections? Is just because Fiscal cliff is more serious than EU economic activity? CAC for example is almost at same levels... thanks in advance.
2y
Mariani Carlo Mariani Carlo
I agree on political risk. For me sell euro usd up to 1,3000 - 1,3300 is a good deal.

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