Wednesday, November 16, 2011

Now its nice to have a small and local bond market!

The past few days in Europe have been amazing.  It is hard to figure out what's the game!  There is a demonstrable liquidity crisis in Europe, with French bonds price falling (as interest rates rise), and even Finland bond price falling -- consider that Finland is the ONLY Maastricht  compliant country... Yet the ECB stands on the sideline waiting for something or someone.  

The latest realpolitik "plot" is that the ECB is at the center of a fight between France and Germany, where France doesn't want the leveraged EFSF program installed (It would kill its AAA rating), and is trying to push Germany to act more unilaterally, while Germany (aka Angela Merkel) wants a more tightly wound Europe (read common fiscal policy with a parliament that has a right of veto on national budget).  

The assumption here is that Merkel has an "evil plan" where she kills democracy (it is certainly the Daily Telegraph's contention -- see Abrose Evans-Pritchard latest missive here.  But the Daily Telegraph is rabidly anti-Europe and assumes a degree of cunning from the Germans and French that has been largely absent so far from the European stabilization exercise of the past 24 months.  However, it is possible that Germany only see's a future for Europe if there tighter fiscal integration -- the implication is less local democracy, but for serious economist this was always a given if the monetary union was to function.

Looking at this as a Canadian, where the bond market is about as domestic as it can be, yes there are foreign buyers of treasury bills (the short end of the curve) but the treasury bond market is a largely Canadian affair.   Moreover, Canadian institutions are already in compliance with Basel III (well at least as it relates to capitalization -- the other bits will take some time), so there is no need for them to liquidate anything.  I am certain that most Canadian investors would look favorably at certain European sovereign bonds -- if the can isolate the currency risk -- because the Euro is seriously overvalued, a consequence of European institutions repatriating funds to Europe (hence driving up the demand for Euros).  

The Canadian bond market is a bit like Japan, a largely "domestic" affair, so as a rule Canada's institutions are looking at the whole European mess (and watch out next week for the U.S. after the "failure" of the Super-committee) and hoping that we can insulate our bond market and financial institutions from the mess in Europe.


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