Checking in on Euro Risk Levels – Pointing in The Wrong Direction

November 10, 2011 8:17 am

Like we don’t know that there is trouble in the EuroZone without charts and tables. Unfortunately, there has been mounting problems that the ECB and other interested parties have attempted to conceal for some time. Now, the high level of rhetoric and low level of action is going to cost them.

Italy has now become the hotbed of concern as the countries key bond rate has surpassed the all important 7% level. As the country has a lack of leadership commitment to figuring out a solution to their growing deficit, bondholders are bailing ship.

The real problem is that Italy’s economy is much larger than that of Greece. In fact, adding together the economy’s of Greece, Portugal and Ireland just start to get close to the size of Italy’s. By most accounts, the EFSF does not have nearly enough money to cover the debt of Italy and that is making investors nervous.

There is already talk of a default:

Italy poses single-biggest threat to the future of the euro, Capital Economics chief European Economist Jonathan Loynes says at briefing in Hong Kong.

Below are the series we track that provide insight into the depth of the risk factors over time.

 

It goes without saying that they are all pointing in the wrong direction. One measure in particular that has become a real worry is the 3M basis Swap. It has just reached -107. To understand more about the implications of this:

An FX swap agreement is a contract in which one party borrows one currency from, and  simultaneously lends another to, the second party. Each party uses the repayment obligation to its counter-party as collateral and the amount of repayment is fixed at the FX forward rate as of the start of the contract.. When the Euro/USD basis swap starts to move lower, it can be seen as a time when the risk of owning Euros over U.S. Dollars is increasing. Many believe that the -100 level is a key level that should be watched and -150 is a time when a crisis is occurring. Currently the level rests at -96.625, the lowest since the time of the U.S. banking crisis.

If that were not enough, there is talk of plans for a Euro exit that is in the works:

Bloomberg:

German Chancellor Angela Merkel ’sChristian Democratic Union may adopt a motion at an annual party congress next week to allow euro members to exit the currency area, a senior CDU lawmaker said.

A motion that proposes allowing a euro member that doesn’t want to or is unable to comply with the common currency rules to leave the euro without losing membership in the European Union has been accepted by the party for debate at the CDU’s annual congress, Norbert Barthle, the ranking CDU member of parliament’s budget committee, said in a phone interview in Berlin. It probably has enough support to be passed by delegates at their meeting in the eastern German city of Leipzig on Nov. 14-15, he said.

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