The ECB Scheme That Saved Europe From Disaster Last Summer Is Practically Dead

"The ECB’s OMT is practically dead," says Joachim Fels, the top economist at Morgan Stanley.

OMT, or "outright monetary transactions," was the game-changing monetary policy construct introduced last year by the ECB in order to reduce financial market stress in the eurozone.

It worked pretty well, too: 10-year government borrowing costs (sovereign bond yields) in Italy and Spain fell from highs of 6.57% and 7.57%, respectively, on July 24, 2012 – levels widely deemed as unsustainable – to lows of 3.76%  and 4.03% on May 2, 2013.

"When we all look back at what OMT has produced, frankly when you look at the data, it’s really very hard not to state that OMT has been probably the most successful monetary policy measure undertaken in recent time," said ECB President Mario Draghi at his June press conference. "OMT has brought stability, not only to the markets in Europe but also to the markets worldwide."

However, by then, things were already changing substantially. Sovereign debt of countries like Italy and Spain has sold off substantially since the beginning of May as a breathtaking surge in U.S. Treasury yields has sparked fears of a reduction in global liquidity.

Naturally, as some of the biggest beneficiaries of global liquidity (the Federal Reserve launched an open-ended bond-buying program around the same time as the introduction of OMT, and in April, the Bank of Japan launched an unprecedented bond-buying program of its own), risky eurozone assets have taken a hit over the past two months.

The chart below, via Citi's Steven Englander, provides a great illustration of just how "practically dead" OMT really is.

"The light blue line is the local currency performance of euro zone banks vs. US banks. For euro zone bank stocks, recent deterioration has unwound all the outperformance since early August 2012, unwinding almost all the improvement since the seminal Draghi risk-easing speech in July 2012," says Englander. "EUR corporate CDS has similarly unwound a significant chunk of outperformance and (relative to the US) is now where it was during the Cyprus crisis and last September."

CitiFX/Steven Englander, Bloomberg

The rise in U.S. Treasury yields is the clear catalyst for this unwind in eurozone financial markets.

"Liquidity-driven markets have just been presented with the antithesis of ECB president Mario Draghi's July 2012 pledge to 'do whatever it takes' to save the eurozone," says Nicholas Spiro, managing director of Spiro Sovereign Strategy. "Perceptions of the Fed's policy actions, as opposed to those of the ECB, are now shaping sentiment towards eurozone peripheral debt."

That, of course, presents a bit of a problem for eurozone policymakers, who for years now have been engaged in attempts to remedy longstanding structural defects in the common currency and, by extension, the euro crisis itself. And since the ECB's introduction of OMT in September, against a backdrop of rising stock markets and falling bond yields, eurozone policymakers have had a pretty nice work environment in which to move forward with complicated integration plans.

Now, "the calm has given way to mild panic," says Spiro. "It's one thing for eurozone leaders to disagree about how to shore up the bloc when market conditions remain benign, but quite another when investors are running scared."

In a note to clients on Sunday, Morgan Stanley's Fels put it thus: "Things haven’t exactly gone well recently: the global market rout has pushed up bond yields in the periphery, political risk is back in Greece, where the government coalition was dealt a blow by the departure of one its partners, and European finance ministers were unable to agree on a new bank bail-in regime and broke off their talks in the early hours of yesterday, leaving an important element of the envisaged bank resolution regime unresolved."

That's why investors should be watching eurozone bank stocks closely.

Citi's Englander warns: "Post-Cyprus and in the absence of an established hierarchy of loss-taking for damaged banks that reassures depositors, any concern on euro zone financial institutions can quickly become a major EUR crisis."

And Spiro agrees: "The repeated failures on the part of eurozone leaders to honour their pledge of June 2012 to sever the pernicious links between vulnerable banks and sovereigns may be coming back to haunt them."

So, is OMT dead?

In his Sunday note, Fels explains why he puts it that way:

What if, say, deflation pressures still intensify and/or the debt crisis flares up again?

I can hear you whispering: ‘the OMT’. Well, here’s the problem.

The ECB says it will only activate the OMT if a government in trouble subjects itself to strict conditionality under an ESM program or credit line. However, any such arrangement would have to be approved by German parliament, and given the Bundesbank’s stiff opposition to OMT and the Constitutional Court’s scrutiny of OMT, I don’t think German parliamentarians would approve an ESM program that they know will trigger OMT.

This is why I believe the OMT is practically dead and why the next big theme for the ECB will be broad-based QE. True, that’s unpopular in Germany too, but at least it doesn’t require a vote in the Bundestag.

If Fels is right, and quantitative easing is in the offing for the ECB, perhaps Mario Draghi will have the chance to save the day in the global marketplace once again.

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SOROS: The Efficient Market Hypothesis Has Run Into Bankruptcy

FA Insights is a daily newsletter from Business Insider that delivers the top news and commentary for financial advisors.

George Soros: The Efficient Market Hypothesis Has Run Into Bankruptcy (Institute For New Economic Thinking)

In an interview with the Institute for New Economic Thinking George Soros argues that the "prevailing paradigm of efficient market hypothesis—rational choice theory has actually run into bankruptcy, very similar to the bankruptcy of the global financial system after Lehman brothers." Soros who founded the institute said it needs to rethink economics.

"[We need a] fundamental rethinking of the assumptions and axioms on which economic theory has been based. because economics has been trying to come up with universally valid laws similar to Newtonian physics and that i think is an impossibility you need a new approach with different methods and also different criteria of what's acceptable."

Three Issues That Have Barry Ritholtz Worried (FA Mag)

In an interview with FA Mag, Barry Ritholtz of Fusion IQ, said there are three financial trends that have him worried. 1. High frequency trading - "It is hollowing out the structure of the markets. Trading is a zero sum game, and if they are making a billion a year, it’s coming from somewhere." 2. "Too Big to Fail remains a problem. Banks should be boring, not speculative super-leveraged hedge funds." 3. Derivatives.

The Chart That Best Illustrates How Gold Was A Bubble (Miller Tabak)

Gold has been taking a hit as investor interest in the precious metal has declined since the precious metal hit its peak in 2011. 

"The current reading of open interest has fallen to 390,647 contracts as sellers drive the price of gold to $1,235," writes Andrew Wilkinson, chief economic strategist at Miller Tabak. "The last time open interest was this low was exactly four years ago when the price of gold stood at $927.40 per ounce. The current market value of outstanding gold positions of $48.24 billion is the least since September 2009 when gold stood at $1,008 per ounce attracting 458,691 contracts."

Miller Tabak/Andrew Wilkinson

Advisors Are Channeling More Of Their Clients' Money To Hedged Mutual Funds (The Wall Street Journal)

Advisors are directing more of their clients' money into hedged mutual funds, according to the Wall Street Journal. These mutual funds   used strategies like short selling that are used by hedge funds with the added benefit that they are more transparent and "can be traded daily." Mark Wilson of The Tabox Group told the WSJ, "we think [they] will hold up the best when the markets get skittish." Some however argue that this could hurt performance as hedge funds have been lagging the broader market

HUGH HENDRY: The 'Invisible Regime' Keeping Volatility In Check Has Become 'Unhinged' (Zerohedge)

"The invisible regime of low volatility and low correlations that had been so supportive of risk markets for at least the last year started to become unhinged," wrote Hugh Hendry, CIO of The Eclectica Fund. 

"The catalyst came from the announcement that the US Federal Reserve may soon tighten its monetary policy following yet another better than forecast US employment figure. The jobless rate in America is down to a four-year low. This purported change of policy however created a chain reaction that spread across global financial markets," he wrote.

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STOCKS SURGE: Here's What You Need To Know (DIA, SPY, QQQ)

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Thunder Dolphin

The U.S. stock market is now on a nice two-day winning streak.

First, the scoreboard:

Dow: 14,910.2, +149.9, +1.0%S&P 500: 1,603.2, +15.2, +0.9%NASDAQ: 3,376.2, +28.3, +0.8%

And now, the top stories:

The Bureau of Economic Analysis published its third reading of Q1 U.S. GDP, and it was ugly. Growth was revised down to 1.8% from a previous reading of 2.4%.  "With the third estimate for the first quarter, the increase in personal consumption expenditures (PCE) was less than previously estimated, and exports and imports are now estimated to have declined," noted the BEA.  Indeed, personal consumption growth was revised down to 2.6% from an earlier reading of 3.4%."The lower consumption estimate provides some indication that the impact from fiscal austerity may have been more than previously thought, and that the economy started the year on weaker footing than previous estimated," noted TD Securities Millan Mulraine. "And with the pace of fiscal austerity accelerating in Q2, some of this weakness should persist in Q2, when we expect the economic recovery to slow even further to around 1.5% q/q."However, the markets barely budged on the release.  If anything, stocks only moved higher.Gold, on the other hand, got demolished again overnight, falling as low as $1,222 per ounce. The 8 Worst Gold Price Predictions We've Ever Heard »In other major developments, the Supreme Court struck down the Defense of Marriage Act (DOMA), which means the federal government will recognize same-sex marriages.Don't Miss: Wall Street's Brightest Minds Reveal THE MOST IMPORTANT CHARTS IN THE WORLD » Follow Closing Bell and never miss an update! Get updates in your Facebooknews feed.

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