Europe's woes deepen

The debt crisis in the eurozone shows no signs of ending as politicians clash and investors cash out.

By Anthony Mirhaydari Nov 27, 2010 7:52AM

Despite some positive developments over in Europe on Friday, with the Portuguese parliament formally approving its 2011 budget and word that Ireland's bailout could be finished over the weekend, traders were in the mood to sell. And sell they did.

 

As they sold Spanish bonds, the interest rate surged to highs not seen since 2002. The cost to protect against the default of debt issued by Spain, Ireland, Portugal, Greece, Italy, and even Belgium all jumped substantially. The euro plunged.

 

The catalyst was chatter that parts of the Irish bailout package being put together by the European Union and the International Monetary Fund could result in defaults on Irish bank debt as soon as early next week. Adding to concerns were rumors Portugal is being pressured to take bailout money. The situation is quickly going from bad to worse.


This is a big change since Ireland has until now acted as if the senior -- or highest quality -- bonds of its now nationalized banks were sacrosanct and would be protected from default. I guess that's not the case anymore as politicians, especially German Chancellor Angela Merkel, look to punish speculators who many believe are responsible for the crisis.

 

When governments change the rules on the fly like this, investors get understandably nervous as previous assumptions are thrown out the window.  Something that looked like a high quality investment starts to stick like soured milk.

 

What they don't realize is that while the fast-and-loose hedge fund types press their bets in the credit derivatives market (or sell cash bonds short), it's the conservative pension funds and insurance companies that are the traditional holders of this debt. And they are the ones who will suffer should the EU-IMF bailout for Ireland require any "haircut" on repayment.

 

Seperately, the Financial Times reported that Portugal was under pressure from the EU to quickly accept a bailout -- the idea being that a quick rescue of Portugal, avoiding the long process faced by Greece and Ireland, would act as a firewall for Spain since Spanish banks are heavily invested in its smaller neighbor. The hope is that this would prevent so-called "contagion risk" from infecting Spain, which may be too large to rescue.

 

This was quickly followed by a parade of officials denying the report.  But this may be denying the inevitable: A recent Reuters poll found that 34 out of 50 analysts surveyed believed Portugal will be forced to ask for help. Remember it was just two weeks ago that Ireland was denying bailout talks.

 

Yet another newspaper report sent German bond reeling on concerns the country will be forced to add additional funds to Europe's $582 billion bailout fund, the European Financial Stability Facility (EFSF).

 

If so, not only would this risk political turmoil but it could undermine Germany's credit rating. For a sense of scale, reports put Ireland's bailout cost at about $113 billion -- but a Spanish bailout could cost upwards of $556 billion according to the team at Capital Economics. Although the EFSF could raise more capital, it would put added pressure on Germany.

 

And finally, political support for Ireland's bailout and associated austerity measures is breaking down. The ruling party suffered a setback this week when it lost a round of local elections.

 

Moreover, the opposition party said that the interest rates the bailout funds will carry-- rumored to be between 6% and 7% -- is too high. With the ruling party maintaining an ultra-slim margin in parliament, this new wrinkle could throw a wrench in the bailout process, which hinge on the approval of a tight new budget early next month.

 


Overall, the picture is clear: With the maelstrom of bad news out of Europe, investors are losing confidence in the idea of a quick resolution and are pulling cash out. You can see this in the chart above, which comes courtesy of the iFlow data maintained by the Bank of New York. Just look at the cash being pulled out of Spain. According to Neil Mellor, the bank's currency strategist, the "flows look similar to what we saw in Greece."


While it's terrible to see the all of this unfolding -- like a train wreck in slow motion -- there are opportunities for profits. Both my regular top Stocks readers as well as subscribers to the Edge Letter have been benefiting from the chaos via various short ETF positions including the ProShares UltraShort MSCI Europe (EPV) and the ProShares UltraShort Euro (EUO).

 

Be sure to check out Anthony's new investment advisory service, The Edge. A free trial has been extended to MSN Money readers. Log in using the following credentials: user name: freeuser; password: edge

 

The author can be contacted at anthony.mirhaydari@live.com. Feel free to comment below. 


 

7Comments
Nov 29, 2010 12:41AM
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pay no mind to the previous gents, we europeans know that unfortunately you present what is the real situation...why is it that you can always smell a liberal by his/her own bile? by the way when "kalifornia" follows spain, who will bail it out? the imf? viva il

socialismo and keep on spending...

good job anthony!

Nov 29, 2010 5:13AM
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I'm learning how to read, write and speak Chinese. Now that's a wise move! Thumbs upWink
Nov 29, 2010 5:10AM
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I agree with Thinking ........................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................ ...........................................................................................................................................................................................................................................................................................................................................................................................................NO ONE! Eye-rolling 
Nov 29, 2010 12:06AM
Nov 28, 2010 11:27PM
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wow that left me wondering where the rest of the article is. lack of real info with other information backing what is there would be nice but I guess this is what we get from short articles


Nov 28, 2010 10:58PM
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Where was the doomsday talk in October a few years ago?

 

Not enough doomsday in the US anymore so we need to stir it up in smaller countries?  This is like saying California is going bankrupt and having the world freak out.  Did the world freak out when Cali was/is having budget issues?

Nov 28, 2010 10:48PM
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Tony the Clown actually wrote this piece of drivel on a SATURDAY??  This guy knows nothing and maybe should stop trying to scare people with his doomsday OPINIONS that are not backed up by the facts he presents.  What an idiot!!
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