Daily Clueless Musings 7/15

The European stress test 2.0 is nothing but a joke. Moody's predicted 26 failures, Eurostat gives us 8. EBA says 5 Spanish, 2 Greek, 1 Austrian Bank fail as of April 30. The so called "stress" scenario does not consider a default by Greece or other peripherals. It is not even close to the probability of default implied by the CDS market. Market cannot wait to sell the short lived rally in Euro. Eurodollar front contracts are also under heavy selling pressure after the release. Yield spreads between the European peripherals and German bonds widened again. Market is not as naive as the European politician hoped to be. The under-stressed stress test won't buy any confidence for the EU banks. According to a report by JPMorgan published on Wednesday, US prime money market funds reduced their exposure to European banks by 11.6 percent to a total of $675 billion at the end of June. Herman Van Rompuy ,President of the European Council, tweeted that a meeting of the Euro area Heads of State or Government will be held on Thursday, 21 July, at 12.00 in Brussels. Maybe a soft default of Greek bonds will be announced? The timing is also perfect. It happens to be just a day before the US debt ceiling legislative deadline. The overhang of debt ceiling issue in the US and the weakness of USD helped buffering the credit shocks.But the time left for EU/ECB to act is running out.

Things are not rosy at all in the States as well. The University of Michigan sentiment index fell 7.7 points to 63.8 in July ,the lowest level since March 2009, despite lower gas prices. Although core CPI came in at 0.25% month over month, higher than expectation, the median one-year inflation expectation fell from 3.8% to 3.4%. The five year inflation expectation fell from 3.0% to 2.8%, approaching the 2.7% level pre-QE2, when deflation rather than inflation was the topic of the time. As long as the inflation expectation remains low and stable, it helps the Fed doves insisting inflation to be "transitory" (AKA the BoE "Bury your head in the sand" way), which may be paving the road to QE3. The weak Manufacturing IP also helps tipping the balance to more easing. Industrial production increased 0.2% in June but May (from 0.1% to -0.1%) and April (0.0% to -0.1%) were both revised down. The key manufacturing production was flat in June and the growth for May was revised down from 0.4% to 0.1%.