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On the impact of Spain and Syria on the markets

September 25, 2012

To follow up on my last post, the Euro recovered. And it’s not over. It should go higher. As should other asset classes, since the ECB, the FED and the BOJ’s actions and declarations were so favourable to the markets.

The only unresolved issue that currently holds the euro zone’s currency and the markets  back today is the Spanish uncertainty about begging or not begging for a bailout.

The Spanish government will outline its 2013 budget to the chambers on next Thursday. The market’s interpretation of this plan and the reactions thereafter should dramatically impact the markets and it will probably be a turning point for Bond yields, equity price action as well as the currency. Time to hold Euro assets. Here is why:

The actual most stringent problem is the borrowing level of the Spanish government facing a number of redemptions of Bonos (government bonds issued by the Kingdom of Spain). This morning 10-year benchmark bond traded at a yield of 5.736%, 419 basis points above its German counterpart, the Bund. When looking at the spread with Italian Government 10-year bond, the BTP trades at 5.146%, 59 basis points only below the Spanish bonds. From what I read on Reuters and the Economist etc…the “street” believes a bailout is unavoidable.  This spread therefore reflects the high probability of a bailout. If the strings attached to it, as they will/should be defined on Thursday or a little later are not too stiff, Spanish bonds should rally, and reach the Italian bonds’ level. If not, the yield will go back towards the 7.00% barrier. By that moment, European equity markets will have dropped witout volume and it will be time to buy while the Euro, which, first would may have returned lower but difficult to catch, will come back “en force”, by the sheer effect of a buying spree on European assets, reaching 1.30 quickly and running towards 1.35 within a fortnight. On the Bonos, in the short run, I would sell “Out of the Money” Strangles (Please check in an option strategies booklet if you are not familiar with the jargon).

Another interesting spread concerns the November delivery prices of Brent Crude Oil and WTI Crude Oil. They are respectively at $110.17 and $92.36 at the moment of writing, with a spread of 17.79. This obviously reflects high uncertainty of supply from the Middle East, given the rising tensions in the region. I really thought the Syrian civil war would be ended this summer but it was without counting on President Obama’s strange declaration that the Red Line for US intervention in Syria would be the use of chemical warfare… Basher Al-Assad rightly understood “it’s OK to kill civilians with conventional (russian) weapons”….

Unfortunately, the Muslim world’s division in supporting one side or the other comforts the West’s inaction. Historically, this sadly reminds us of the Spanish Civil War, in 1936; rehearsal and weapons test ground of the Second World War. Mild and secret Western support to the rebels won’t help, and volatility and high Brent prices will prevail, which explains why Saudi energy officials try to contain them with their declarations in the last couple of days.

Moneywise, Conflicts and energy prices fuel inflation expectations; gold goes up. At 1766, it still has room upwards.

 

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