After a few days of the markets backing off of fighting the ECB, I thought it would be interesting to review some European Sovereign Debt metrics. Whilst equity markets and are enjoying a relief rally and a return to the bias towards risk assets (propelled by Quantitative Easing 2) it is far from clear whether the underlying fundamentals have been dealt with. This could take time.
Firstly, looking at Spain/German Yield 10 Year spreads...
reveals that they are still elevated. Similarly, Spain 5 Year Senior USD CDS
Portuguese 5 Year Senior USD CDS
However, it appears that the Federal Reserve at the ECB were entirely right to act quickly to avert 'Ireland' turning into 'Greece'. It is my opinion, that there were liquidity problems with some European Banks in Q2 and, some stress metrics for the banking system reflect this. Here is the 'Ted' Spread. In other words, the difference between short term interbank loans (LIBOR) and US Government debt (3 month T-Bills)
So it appears that QE2 was entirely justified!
I think there is a risk that this sort of game could continue in 2011. Spain's recent PMI numbers were signalling contraction recently and their housing market is far from being out of the woods.
I run a hedged portfolio with a bit of a discretionary element by which I play with delta. Right now I have the portfolio positioned with a cautious stance.