The battle for salience

The battle for salience between the positive situation in the US and the deteriorating situation in Spain continues. I am finding it very hard to see which if these is likely to dominate the markets in the next couple of months. I have been thinking about German CDS this morning, and in particular having a look at some German companies. If the European situation gets much worse, and the European recession drags on and on, then German companies — and especially exporters that are exposed to the periphery — should see their CDS spreads widen. I wonder whether there might be a trade here.

On the unavoidable subject of Spain, Bloomberg reported last week that the country has sold enough bonds that its funding is secure for the rest of this year. That would suggest that any actual need for a bailout is still some months away. On a similarly positive note, I cannot see at this stage any reason why Italy, whose fiscal dynamics look much better, should be “dragged in” to the current spread-widening episode. Whether Spain’s solvency will be called into question will depend on how questionable it actually is — and that is an area on which I need to update my research.


The first round of talks with Iran happened over the weekend. Both sides called the talks “constructive” and agreed to meet in May to discuss substantive issues. Iran apparently dropped its preconditions and agreed to discuss the nuclear question.

What is going on? In a way, Iran’s behaviour is explained by a simple model: the Western sanctions have actually hurt Iran and caused the leadership to fear for its position, so the leadership has agreed to negotiate. “Because we remained strong, the Soviets came back to the table,” as Ronald Reagan said in front of the Brandenburg Gate. As I have said before, the question we need to answer in order to predict Iran’s actions is whether the regime is bonkers or not. If it is not, then a rational model can be applied; if it is, then we need to understand its madness in order to predict its actions. Saddam Hussein was bonkers — he liked to hint that he had WMD and thought that an invasion would never happen. But the Iranian regime is not a dictatorship and it is composed of men who have, at least, proven their ability as theologians. They should be capable of rational thought. I tend to think of Iran as a rational actor with different interests from the West, and that has proven the right way to think about it in the present episode. But I could be wrong.

European Politics

Campaigning for the French presidential election is entering its final week, with Hollande leading Sarkozy by 56 to 44 in a second-round runoff. I am not especially concerned about an Hollande victory. Yes, he may attempt to reopen some European negotiations, but it will not be in his interest to cause a serious rift with the rest of the Eurozone; most likely he will attempt to extract some token concessions (although the sound and fury may upset the markets for a period).

Bloomberg has an interesting article about German politics, in which it points out that the SPD is in favour of “Euro-bonds” — i.e. a single Eurozone government bond. This is a very interesting point. With the CDU’s coalition partner the FDP in danger of collapsing below the threshold for representation in parliament, the federal election in 2013 could, on current opinion polls, produce the conditions for another “grand coalition” between the two main parties — and a change of European strategy might be the price the SPD extracts for this. Opinion polls can move a lot in a year, of course. The interesting point is that Germany could, theoretically, be just an election away from a proper fiscal solution to the European crisis.


  • US CPI 2.7% YOY b.e. Mar. Core 2.3% a.e. Headline CPI continues to decline YOY.
  • Prelim Michigan sentiment fell a little to 75.7, d.e. Leading indicators seem to be deteriorating at the margin in the US, although there are not yet enough releases to update my leading index.
  • UK Rightmove HPI 2.9% MOM April — the third month of gains.
  • Italy trade deficit was on the narrow side, b.e., Feb. Further evidence that Italy may be doing OK.

This Week

  • US retail sales (Mon)
  • Australia monetary policy minutes (Tue)
  • UK CPI (Tue)
  • US building permits and housing starts (Tue)
  • US industrial production and capacity utilisation (Tue)
  • Eurozone current account (Wed)
  • UK employment data (Wed)
  • UK MPC minutes (Wed)
  • Japan trade balance (Thu)
  • US existing home sales (Thu)
  • German Ifo (Fri)
  • UK retail sales (Fri)