Telling the whole story

Dear readers, I will spare you all the definitions previously laid out in this space ad nauseam, but please do not get bored with these regular Target2 updates, as they will become a lot more interesting very soon. Yes, the German Bundesbank released those numbers yet again on Monday, for the month of January. That the imbalance would have continued to worsen shouldn’t come as a surprise, the magnitude should.

From December the German Target2 surplus increased by 41.4 billion Euros, and now get this… from January last year it soared by 208.6 billion. Currently, the Bundesbank is sporting a positive Target2 balance of almost 800 billion Euros, actually 795.6 billion to be exact. And again, we have hit an all-time high which is another testament that economic imbalances within the eurozone are truly getting out of whack.

Important to know is that the current account isn’t the major culprit for this phenomenon any longer. The periphery countries are getting poorer and poorer, and if anything they have maintained more or less balanced trade accounts for a while now. Italy even manages to churn out a small trade surplus these days, not because they export so much, but they can’t afford to import at pre-crisis levels.

So what’s the reason then for this eye-popping divergence within the eurosystem’s fund flows? For the n-th time, it is capital flight. Money is running for the hills in southern Europe, or should we say for the Alps, and it typically ends up on the other side in Germany. In order to keep the eurozone together it needs to be channeled back to the deficit countries via the ECB. It is the only way to keep them solvent and the monetary union alive.

Never were Germany’s receivables vis-a-vis the eurosystem so high, that is implicit periphery government bond collateral on the Bundesbank’s balance sheet, not even at the height of the eurocrisis in 2012. Only the ECB-induced tsunami of excess liquidity can paper over the cracks, but as they say, there is no free lunch. More central bank money also means more capital flight, and so the dog is chasing its tail.

This is the real reason why Mario Draghi insists on printing ever more. He understands what is at stake but has his eyes wide shut when it comes to the consequences of his policy. He can rebut Donald Trump’s comments however often he wants, even before the European Parliament like he did elaborately, no one in their right mind will listen to him anymore. He is the truly tragic figure on this European opera stage.

Markets are giving us a hint already of what’s to come. 10 year French yields blew out to beyond 1.10% across the latest 2 trading sessions, while Bunds u-turned and closed lower at 35bp. The differential between the two has not been as wide since 2012. To be sure, the noise around Marine LePen has aggravated the situation, but in the end it is only a trigger for the inevitable. Capital flight will also intensify from France to Germany.

Buy Bunds, sell Frenchies and periphery, will be the trade for some time to come, but maybe not for too long. You will have heard that the newly elevated SPD nominee for the German chancellorship, Martin Schulz, is riding a wave of an electoral upswing and according to one latest poll has eclipsed Merkel’s CDU. Imagine for a moment he can hold that momentum and leads Berlin into the much commented on Red-Red-Green coalition…

Money wouldn’t know where to move quickly enough, as in such a case the capital flight could actually commence from Germany. The only question is where to…? In FX markets this might later be recalled as the death-knell of the Euro.