(By Ed Pawelec) "Who is more foolish: the fool, or the fools who follow
-Obi-Wan Kenobi, Star Wars IV: A New Hope
Early yesterday morning, around 6 AM New York time, market
fears were wiped away. Relief came in the form of soaring
global markets, as concerns about a Greek exit, a full-blown
Spanish bailout, and a struggling global economy were laid to
Investors can thank Jedi master Mario Draghi (got my Mario right
this time!). The European Central Bank president's sage words
and indomitable confidence sent Spanish and Italian yields tumbling
all the way from the danger zone to still
"The Euro is like a bumble bee... It shouldn't fly and yet it
does... probably it was something in the air... now it needs to
graduate into a real bee... we will overcome the natural
selection of the markets."
I am not making this up. Mario-Wan Kenobi said this
during yesterday's "risk-on" press conference. I guess he
won't be going into biology after he wraps up his stint at the
Seriously, however, what got the markets going was his
full-of-confidence (feel free to replace "confidence" with any word
you believe appropriate) remarks that the ECB would do whatever it
takes, within its mandate, to sustain the euro adding, "believe me,
it will be enough."
That was it. No action. No specifics on future
actions. But can the calming influence of a Jedi master
really send the markets on their way to new highs, or is the upside
move set to evaporate as quickly as it arrived?The Light Saber
The light saber is the weapon of choice for the Jedi, and while
Mario isn't a real Jedi, the weapon he has been called upon to use
is supposed to have the power of a blade of energy. I am
talking about the Securities Market Program (SMP).
Dreamed up in 2010 to save Greece from the ravages of unsustainable
interest rate levels, the SMP is a means to circumvent the ECB
prohibition against buying sovereign debt. Legally, the ECB
cannot buy debt directly from or lend directly to a
sovereign. The SMP allows the ECB to purchase government debt
in the secondary market from the original buyers of the debt,
mostly European banks.
This works by pushing rates on existing similar maturity debt lower
so that when the respective governments go to market with an
official auction, rates are comparable and low. Spain, for
example, has about €50 billion of funding to raise over the next
few months -- bailouts aside. The Spanish 5 year note was
trading north of 7.3% prior to Mario's Jedi mind tricks
yesterday. By the close of European business on Thursday, the
5 year yield was down to 6.57%.
Using an SMP style weapon over the next few months might push the
yield under 6% by the time Spain has to go to auction again in
September. As with past efforts, it is a kick-the-can measure
that falls apart as soon as the ECB steps away from the
The first round of SMP lasted from May, 2010 to July, 2010 and
pushed Greek 5 year yields down from north of 13% to around 8%, but
by the end of 2010 yields were hitting new highs. Currently,
there is no liquid market for Greek debt but, according to
Bloomberg, the estimated 5 year yield is north of 60%.
With Greece pretty much done for last fall, the target of the
second round of SMP was Spanish and Italian debt. As both
countries' 5 year yields shot toward 5.5%, the SMP action initiated
in August, 2011 brought both yields down to around 4.25%.
That round only lasted a few months, and by November both Spanish
and Italian debt was soaring above 6%.The Death Star
Since these efforts were clearly ineffective, it was time to bring
out the big guns. In November, the ECB announced its "Long
Term Refinancing Operations" (LTRO). Remember, the ECB cannot
buy sovereign debt directly from governments, but it can lend to
its member banks and they can do whatever they want.
So Spanish and Italian banks took the domestic government debt it
had on its books, pledged it to the ECB as collateral to borrow
money at 1% to buy more of their countries' debt yielding 3, 4, or
5%. The LTRO was so effective that another round was
announced in February, 2012. Both Spain and Italy took
advantage of the reduced rates during the first half of the
year. But when the €1 trillion in this easy money shell game
dried up, yields were off to the races again. Just a few days
ago Spanish rates were hitting record highs.
The point is that whatever measures were or are taken, the impact
is fleeting and is only effective while said measures remain in
place. When SMP, LTRO, QE, Twisting, etc. end, the market's
"natural selection" mechanism moves rates and equities back toward
more accurate risk adjusted prices. That cannot be overcome
in any lasting sense.
Until a massive amount of debt is simply written off and Europe
either falls apart or establishes a credible fiscal union, I will
continue to sell the rips, because these rallies are neither
sustainable nor the beginnings of a new bull market."Your eyes can deceive you, don't trust them."
-Obi-Wan Kenobi, Star Wars IV: A New Hope