Professional investor: “The possibility that the Euro area collapses should be seriously considered”

Peter Rivers, Chief Investment Officer (CIO) of One River Asset Management, has written a few things about Zerohedge that we allow us to share. “We have always known how to fight this fragmentation: in 2010, in 2012, in 2020, each time with different tools,” said Villeroy of the European Central Bank. “Nobody should have doubts, even on the markets, about our collective will to avoid fragmentation,” continued the Frenchman, as spreads on Italian government bonds widened and interests skyrocketed. "We have the will and no one should doubt that we will have the tools if and when it is necessary". But that, of course, has left those of us who are paid to entertain doubts wondering what will mark the point where the European central bank will need to intervene in the markets, creating euros and then buying peripheral bonds.

"There are no specific levels of increases in yields, or in loan rates or bond spreads that can unconditionally trigger this or that," explained Christine Lagarde, ECB president, when asked for details.

"We will determine on the basis of circumstances, of countries, how and when this risk can materialize and we will prevent it," he said, hoping that such ambiguity will discourage speculators from pushing markets to the point where the central bank has committed to act. "But we are committed – committed – to ensuring a correct transmission of our monetary policy and consequently fragmentation will be avoided to the extent that it could compromise this transmission," said Lagarde confidently.

But no two crises are alike. In 2010, 2012 and 2020, European inflation in northern Europe was practically non-existent. In 2012, when President Draghi said the ECB would do "whatever it takes", European inflation was 2.35%.

In a world of perpetually low inflation, the power of central banks to create money with which to prevent fragmentation – also known as a cohesion subsidy – appears limitless, without cost. But in a world of high and rising inflation, subsidies risk raising inflation and breaking expectations.

Investors need to consider all outcomes and assess the likelihood that Northern Europeans will be willing to bear these costs on behalf of their Southern neighbors now that EU inflation is at 8.1%.

Peter Rivers' observation is true, but only partially: GENERALIZED intervention by the ECB on all securities is not possible, but TARGETED intervention on one or a few issuers would be sufficient to avoid splitting. A normal central bank would buy the problematic stock and leave the others affected. Too bad there are problems:

• the first is of a legal nature. The TFEU theoretically prevents this type of intervention. In fact, the ECB usually applies, or pretends to apply, the "Capital Key", that is, it purchases securities in proportion to the participation of the Central Bank in the ECB. The ECB circumvents the rule from time to time, but only because they agree;
• The second is much cheaper. Italy has lower inflation than Germany, especially Core, so the operation should not cause problems, given that the small stimulus (small, because in any case we are already following the European budget constraints) would go to those who have a lower inflation. But here the European demagogy intervenes, so even this small incentive is not good.

So the Eurozone actually risks jumping, but for a specific choice of some countries, and not Italy. In these conditions, the market has understood that the famous "Anti-splitting tool" is NOT needed, simply because it does not exist, in our conditions, because they do not want to make it exist. Under these conditions the Euro Zone can very well jump.

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The article Professional investor: “The possibility that the Euro area collapses should be seriously considered” comes from ScenariEconomici.it .

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This is a machine translation of a post published on Scenari Economici at the URL https://scenarieconomici.it/investitore-professionale-bisognerebbe-considerare-con-serieta-la-possibilita-che-larea-euro-collassi/ on Tue, 14 Jun 2022 07:00:53 +0000.