Roiled OATS spread panic in Europe and opportunity Down Under

Friday, 14 June 2024

[6 min read]

Dear Reader,

Financial markets are having trouble digesting the European Parliament elections. They’re supposed to be incredibly unimportant. The European Parliament just rubber stamps what the unelected European Commission sends their way.

But the results managed to cause chaos in stocks and bonds. It even made the top story on News.com.au!

So, what’s going on? And is there a profitable angle surprisingly close to home?

Over at Strategic Intelligence Australia, we were ready for this moment.

On the 15 March I wrote: ‘I believe the European Union elections in June may well deliver some serious financial market volatility akin to the 2010-2014 period.’

What sort of serious financial market volatility was that?

‘The sovereign debt crisis is the most relevant to financial markets and investors. If the EU is weakened, we may be back to the bad old days of 2012, when all markets were roiled by fear of a major financial crisis in the eurozone.’

Sure enough, that’s exactly what happened.

The excellent financial Journalist John Authers sent out an alert in response: ‘The French Connection may not withstand this,’ it said.

Just like sub-prime and the pandemic, this crisis has its own jargon. Which we’ll all become painfully familiar with in coming years…

‘The OATS Spread is not one of those financial metrics you hear discussed very much. That’s good, because if people start talking about it, that’s almost certainly a bad thing. Like the plumbing in your house, you ignore it unless something goes wrong, and then nothing is more important.

‘So, the bad news is that the OATS Spread (the gap between the yields of 10-year bonds issued by France, known as OATS for obligations assimilables du Trésor, and German bunds) is back at the center of discussion. It’s just surged in a remarkable way.’

The gap between French and German government bonds hit the highest level since the beginning of the pandemic.

It was such ‘bond spreads’ which gave the European Sovereign Debt Crisis their meaning between 2010 and 2018. Only, this time, it’s France at risk.

They measure how much more the French government would have to pay to borrow money than the German government. It indirectly tells you the risk of France doing something crazy, like defaulting on their debt or leaving the euro.

It also tells you how much bond prices crashed. Those losses are sitting on someone’s balance sheet. Perhaps a French bank that’s now in trouble. Just as US banks were last year, when they went bust because of tumbling US bond prices.

And so stocks dropped too. Especially the European banks. First on the EU election results. And then on the news of a surprise French election.

But does a roiled OATS spread really impact you? It certainly can.

A painful reminder

Back in 2018 I warned about Italy facing the same crisis. A populist Italian government was elected to take on the EU and European Central Bank. The bust up delivered the worst financial market returns since 2008.

So it does matter, a lot.

It was all papered over in the end, of course. And so the Italians elected an ever more eurosceptic party into government at the next election. But they’ve been suspiciously pro-EU and euro since too.

Much the same happened in the UK in September 2022. Which I didn’t predict. The eurosceptic free-marketeer Liz Truss came into power and announced large tax cuts. The UK bond market had a heart attack over the increased deficit. Much of the pension system almost went bust.

The Prime Minister was soon replaced by a Goldman Sachs alumni. As usually occurs after a bond crash in Europe.

So, none of this is new. It’s just that France is a lot bigger than the likes of Greece, which needed an actual bailout.

It’s also difficult to know whether the next French government will give in to the European establishment like all the others did.

The party leading the polls are described as far right, but their economic policies are rather far left. Will the ECB and EU approve?

Another new factor is that there seems to be rather a lot of “far right” governments in power across Europe these days. Does their combined pressure add some sort of weight?

I don’t know. But we’re going to find out the hard way. Because all of those governments were only brought back into line by the consequences of picking a fight with the EU: financial market volatility.

An opportunity in the making?

Europe’s crisis will be Australia’s gain. And not just because of our comparatively low debt to GDP ratio.

The most important result in the European Parliament elections was the decline in support for green parties. The European electorate has had enough of the energy transition.

Instead, voters came out in force for parties that have long supported nuclear power. They’ve been vindicated by Europe’s energy crisis.

The new Dutch government is planning on adding four new reactors to its existing one, for example. Even the party leading the polls in Germany is considering reversing the phase out of nuclear too.

But all this unexpected nuclear power needs a lot of uranium fuel. Preferable from a country not tied to Russia, which has a stranglehold on nuclear fuel supplies.

Can you think of one?

It’s only the latest shift in support of nuclear. Artificial Intelligence may be the most important one. It will create a big enough demand for baseload power to force the issue in favour of nuclear. And in favour of ASX listed uranium miners.

But nuclear is not the only industry which AI will unleash. My long-suffering friend Callum Newman has put the hard yards in. He identified which Aussie stocks stand to benefit most from the new tech. Find out more here.

Until next time,

Nick Hubble,
Editor, Strategic Intelligence Australia

Nick Hubble found us at Fat Tail Investment Research in 2010 after a stint inside Wall Street’s most notorious bank, Goldman Sachs, during the 2008 GFC. That’s where he saw the true nature of the investment banking business. Since then, he’s been the editor of the Daily Reckoning Australia and the UK-based Fortune & Freedom and Gold Stock Fortunes.

He’s delighted to work as Investment Director and Editor for Jim Rickards’ Strategic Intelligence Australia. Here he helps turn Jim’s big-picture views into specific actionable advice and ideas for Australian investors.

[3 min read]

‘History has many cunning passages, contrived corridors

‘And issues, deceives with whispering ambitions,

‘Guides us by vanities.’

Gerontion, TS Eliot

Investors heard the lure of the Lorelei yesterday. So sweet. Irresistible. What lush pleasures they suggested. What otherworldly satisfactions they offered.

Yes, word came that inflation was ‘cool’. Business Insider reports:

‘Inflation came in softer than expected, with consumer prices remaining flat over the month of May. On a yearly basis, inflation was up 3.3%. That's slightly lower than the 3.4% yearly increase recorded in April, marking the second month in a row that prices have cooled.

‘Bond yields plunged after the report. The 10-year US Treasury dove 11 basis points to 4.287%

‘"Wednesday's weaker-than-expected CPI will allow the Fed to start cutting interest rates as soon as September since we have now seen multiple encouraging inflation readings, after the concerning spike in inflation earlier this year," Skyler Weinand, the chief investment officer of Regan Capital, said in a note. "There's a clear path to a soft landing and the Fed may very well be coming to the market's rescue in as little as three months."’

Markets Insider followed up:

‘US stocks rose on Wednesday as investors took in cool inflation data and the Federal Reserve's latest guidance on rate cuts, helping the S&P 500 to another record close.’

But then, the Dow gave back all its gains when it became clear that Jerome Powell was not exactly on the rate-cut bandwagon. It was “certainly a better inflation report than almost anyone expected,” he said. But he added that he wanted to be sure inflation was under control before cutting rates.

Boo hoo. Investors will have to wait for the lavish satisfaction they crave.

But Fed rate cuts do not magically create more real wealth. Wealth is created by increases in productivity…with more output per unit of labour and resource input. It is the result of hard work…and forbearance. Immediate pleasures must be put off…lessons must be learned. Capital cannot be consumed; it must be saved and invested wisely, skilfully. Everything else is distraction…fraud and fantasy.

After revealing the Fed’s decision not to cut rates any time soon, CNN added:

‘That means borrowing costs on everything from car loans to mortgage rates will remain elevated.’

Lowering the cost of credit makes it easier to buy things….but it doesn’t necessarily make it easier to pay for them. As we’ve seen, more credit creates short-term ‘fictitious’ wealth, not long-term real wealth. Sellers record the increase in sales as a plus. The feds record the extra sales as an increase to GDP. But until the bill is settled, the transaction is incomplete.

As debt increases so does the cost of debt service (interest) and the number of debtors who won’t be able to pay – including the biggest debtor in the world, the US government. And so does the amount of wealth that is likely to vanish in the next crisis. This is especially true when the borrowing was done under false pretences – that is, at interest rates that are unrealistically or artificially low.

And lo…the debt rises.

The latest figures are out. The Congressional Budget Office says that the feds’ deficit for the month of May was $348 billion – up $108 billion from last year. Whew. The CBO is forecasting deficits between 5.2% and 6.3% of GDP over the next 10 years.

This is a nation going broke in the traditional way…by adding phony wealth and real debt. And here, we’re not the only ones to notice. The Financial Times is on the case:

‘The IMF’s second-in-command has urged the US to shrink its mounting fiscal burden, saying strong growth in the world’s largest economy gave it “ample” room to rein in spending and raise taxes. Gita Gopinath, the fund’s first deputy managing director, said it was time for advanced economies to “invest in fiscal consolidation” and address how they plan to bring debt burdens back down to pre-pandemic levels.

‘“For the US, we see ample ground for them to reduce the size of their fiscal deficits, also given the strength of the US economy,” she told the Financial Times in an interview. The warnings come as economists and investors fear that years of fiscal profligacy by both Democrats and Republicans are storing up trouble for the US economy.’

Yes, dear reader, there is ‘ample ground’ to cut spending. But fraud is more agreeable than truth…and increasing debt is much more appealing than paying it off.

For now, policymakers and investors are enchanted by the song of the Lorelei and the fake wealth it produces. Later, they will crash upon the rocks.

Regards,

Bill Bonner,
For Fat Tail Daily