Monday, December 5, 2011

Today's Major Market Move: Spanish 5 Year Credit Default Swaps Decline 8.9% in Monday's Session

The positive trend for European markets continued today as there was a favorable reaction to the news that Sarkozy and Merkel were pushing for a new EU treaty to strengthen the fiscal rules and supervision of the member states. Some details of the proposal from NPR:
— Automatic punishment for any government that allows its deficit to exceed 3 percent of GDP. Governments are supposed to follow this rule already, but many, including France, have flouted it.

— Requiring countries to enshrine in law a promise to balance their budgets.

— Never again asking private investors to take losses, as a bailout of Greece did.

— Making Europe's bailout fund permanent by the end of next year, rather than mid-2013.

— Holding monthly European summits until the crisis is over.
Regarding item #1: If the punishment takes the form of some kind of monetary penalty (i.e. fine), won't this push a country even deeper into the financial hole that they are already in?

Regarding item #2: Lovely idea in theory. Not so great in practice. Just take a look at the U.S..

Regarding items #3 and #4: Time to add to gold and oil positions.

Regarding item #5: If monthly summits are good, wouldn't weekly summits be even better? I'll bet daily summits would bring the Italian 10 year down to 3%.

So even though I'm a little skeptical of these proposals, the markets thought they were great ideas with both European equities and credit default swaps performing well. Spanish 5 Year CDS were the best performer on the day, declining 8.9%. I put a chart together to see how PIIS CDS have performed over the last month and a half (I'm leaving Greece out because their CDS pricing has been really wacky as a result of their default):

Click here to go to the live chart.

So Merkozy (or Sarkerkel?) have to be happy with market behavior over the last week as Italian and Spanish CDS have improved significantly. However, a big part of the CDS action might have to do with treaty proposal #3. If that one is enacted, buying European CDS would be like buying fire insurance on a house that has zero probability of burning down. In fact, I was surprised that anyone was still buying European CDS after the Greece default was ruled as not being a credit event.

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