"...a chain of events that could lead to implosion has been unleashed...

"2012 started so well.

The LTROs allayed market fears about a liquidity crisis...
and created additional demand for periphery sovereign debt during the first quarter.

...it is now time to face the fact
that the market does not believe Schäuble's firewall works.

Most urgently, the market fears a Greek exit,
or the reintroduction of capital controls to stem deposit outflows,
might spark deposit flight ...across a number of other countries.

Playing down the importance of a Greek exit now is hardly reassuring,
when Mario Draghi said the consequences for the Eurozone would be 'incalculable'
only last December.

While the lack of an elected government in Greece complicates matters,
the market sees a growing risk any new government
will not be able to make the concessions demanded by the Troika quickly enough
– or at all.

Then what?

...the firewall must be reinforced
at least with a pan-European deposit guarantee scheme of some form.

...it is not easy to sell politically in Germany.

...there is no clarity on where the funding necessary
to recapitalise the Spanish banking system will come from.

It may be that LTRO-driven bank demand can sustain the auctions for now,
but it seems likely to us that foreign investors will continue to pull out.

Add in ...the persistent negative bias in the economic data relative to consensus,
the upcoming Irish referendum,
all the funding Italy still needs to do this year
and the prospect of Portuguese PSI discussions in only a few months
– and it is small wonder that ...confidence is breaking down.

Through the LTROs and extremely low interest rates
policymakers have ensured that financial markets are flush with cash.

...the uncertainty is killing any incentive to take risk.

What goes in financial markets generally goes in the wider economy too.

Companies are flush with cash, but we struggle to see them investing
...while there is no visibility on the Euro project.

Meanwhile, things grind to a halt.

...We can see in the election results and the opinion polls
that a large part of the electorates are not onside...

...There seems to be a dangerous perception in many places
that enough has been done already.

...We could be close to the breaking point.

Already in the last week there are clear signs
...that the selloff is becoming more systemic.

If you have come across our 'five phases of grief' framework
– it appears we are moving straight from 'depression' back to 'anger'.

Until the gravity of the situation is made clear,
until the self-reinforcing mechanisms that already seem to be in motion are understood,
we don't see how the solutions, the answers, and the certainty that market craves
can be brought to the table.

...We can't escape the sense that it is probably politically easier
to let the markets run loose for the time being
to make it apparent that further intervention is needed.

...every bark comes with a loss of credibility
– a loss of faith in the institutional capacity of the European Union
to address the fundamental imbalances..."

Yours sincerely,

...Credit Strategy