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from Global Investing:

Research Radar: Greek gloom

Greek gloom dominates the start of the week as new elections there look inevitable and talk of Greek euro exit, or a Grexit" as common market parlance now has it, mounts. All risk assets and securities hinged on global growth have been hit, with China's weekend reserve ratio easing doing little to offset gloomy data from world's second biggest economy at the end of last week. World stocks are down heavily and emerging markets are underperforming; the euro has fallen to near 4-month lows below $1.29; safe haven core government debt is bid as euro peripheral debt yields in Italy and Spain push higher; and global growth bellwethers such as crude oil and the Australian dollar are down - the latter below parity against the US dollar for the first time in 5 months.

Financial research reports on Monday and over the weekend were just as gloomy, but plenty of interesting takes:

Bank of New York Mellon's Simon Derrick's view of the Greek political impasse concluded "there is at least an evens chance that the latter part of this summer will see what had officially been seen up until last November as an impossibility: a nation leaving the EUR."

RBS's Sanjay Mathur reckons that if there is another hung parliament after new Greek elections, implying no significant voter return to the pro-bailout parties, then euro risk soars.  "This means, on another hung parliament, that Greek government IOUs could trade as proxy currency as early as July." If that does not galvanize sufficient parties into accepting Trioka bailout demands at that point, he said that then exit looms. "Opening up the Pandora's box of exit means deposit risk across the periphery. The future of the euro would then be dictated by the subsequent policy response."

Barclays Sree Kochugovindan talks of a three phase possible deterioration of the euro crisis -- one, where solvency concerns and asset market fright are contained to Europe and mostly the fixed income markets of the periphery countries concerned; two, solvency concerns hit the core such as France and Belgium with asset market contagion widening before a series of major policy responses; and three, no major policy response or ECB SMP/LTRO, which leads to Greek default and even exit and global market shock akin to September 2008. "Given the immense cost of a crisis triggered by a Greek exit, we are not expecting the current situation to deteriorate into Phase 2. However, the risks are elevated and with the prospect of second round Greek elections in a few weeks, market jitters are likely to continue."

Deutsche Bank's global markets note also focuses on rising risks from Greece and also on the May 31 Irish referendum on the EU fiscal pact. Apart from outlining obvious risks to the Greek financing from a political vacuum, one conclusion Deutsche comes to is that a new EU growth pact may happen sooner than many had figured. "The new situation in Athens forces EU leaders to find common ground faster than we thought." Another conclusion was that Ireland may consider postponing its referendum, given the risk that a "no" vote may disastrously cut off its access to new EU funds and also given a possible delay in German parliamentary votes on the fiscal deal to June. "Ireland might do well to think about postponing the 31 May referendum." It called Spain's sweeping banking reform plan "making progress" but a 15 bln euro government recapitalisaation of the banks "too timid".

HSBC's Karen Ward and Simon Wells warn about the long-term impact of continuous quantitative easing by central banks, saying the political relationship between central banks and governments rather than inflationary consequences may be the biggest concern. "The heyday of independent central banking could be drawing to a close."

from The Great Debate UK:

Hollande’s programme marks return of the Ancien Régime

By Laurence Copeland. The opinions expressed are his own.

Seeing the dewy-eyed kids at the post-election celebrations in Paris, I couldn’t help thinking how crazy it all was. The youngsters were plainly convinced they had a president to take their country forward into the new dawn -  after all, he campaigned under the slogan  “Le changement, c'est maintenant”. In reality, Francois Hollande’s programme is unambiguously regressive, with its stop-the-world-we-want-to-get-off determination to go in the opposite direction to every other country, its refusal to countenance any erosion of the country’s ruinously expensive welfare state and its complacent confidence that there is nothing to stop France carrying on as before. What better place to greet the return of the Ancien Régime than the Place de la Bastille?

Of course, the new President promises that he is going to balance the budget in 2017 with the familiar prayer of tax-and-spend governments the world over: “Oh Lord, make me solvent! – but not yet…” Now, even allowing for the fact that France’s deficit is only 5 percent of GDP, it still means he is going to keep on borrowing until the national debt is more or less as large as GDP. (Remember: a balanced budget means no need for more loans, so the national debt is constant. To start paying off its debts, a country needs a surplus, something France has not managed for more than forty years).

Then, of course, the biggest question of all: how on earth is this fiscal miracle of a balanced budget going to be achieved, given the raft of spending commitments which so delighted Socialist voters? It’s rather like listening to someone promising to lose weight while he tucks into a large plate of chips.

However things work out, you can be sure that the burden of paying for France’s public sector will not be borne entirely by today’s taxpayers, given that France is already one of the most heavily taxed countries in the Western world and that a 75 percent tax on the super-rich will probably raise very little revenue (at least for France – it may end up raising tax revenue for Britain, of course, if the rich move to London).

More likely, France will push its borrowing to the limit, so that, unless it actually defaults a la grecque, the debt will have to be repaid by the next generation or two, in other words by the very same youngsters who cheered themselves hoarse in the Place de la Bastille on Sunday evening.

How will they pay if they don’t have jobs? That’s what they really want – or so we are told.

from Global Investing:

Research Radar: Beyond Hollande and Holland…

Markets have been dominated this week so far by the fallout from Sunday's French presidential election, where Socialist Francois Hollande now looks set to beat incumbent conservative Nicolas Sarkozy in the May 6 runoff , and the collapse of the ruling Dutch coalition on Monday.  Public anxiety about budgetary austerity in Europe was further reinforced by news on Monday of a deepening of the euro zone private sector contraction in April. That said, euro equity, bond and currency prices have stabilised relatively quickly even if implied volatility has increased as investors brace for another month or so of political heat in the single currency bloc. The French runoff is now on the same day as the Greek elections and May 31 sees Ireland going to the polls to vote on the EU's new fiscal compact.  Wall St's volatility gauge, the ViX, is back up toward 20% -- better reflecting longer term averages -- and relatively risky assets such as emerging market equities remain on the back foot. The euro political heat and slightly slower Q2 world growth pulse will likely keep markets subdued and jittery until mid year at least. At that point, another cyclical upswing in world manufacturing together with the passing of the EBA's euro bank recapitalisation deadline as well as the introduction of the new European Stability Mechanism may well encourage investors to return at better levels.

Following are some interesting tips from Tuesday's bank and investment fund research notes:

- JPM economists reckon finding the reason behind the backup in US weekly initial jobless claims over the past couple of weeks is key to assessing whether a sub-par March payrolls report is repeated in April. It says it's possible the claims jump move is a seasonal factor as unadjusted claims are closely tracking 2007's pattern and Easter holidays fell on the same dates in both years. If 2007 was repeated, there would be a sizeable late April drop in claims and JPM looks for some of that on Thursday with a 14,000 forecast drop. (Reuters poll consensus is for a 11,000 drop)

- Following the surprise news last week that dovish Bank of England policy maker Adam Posen is no longer voting for more UK money printing, Barclays FX team said it's turning more positive on the UK economy and also says sticky inflation may mean the Bank of England's current monetary stance may be too accommodative. As a result, it lowered its euro/sterling 3-month forecast to 0.79 from 0.84. However, it cautioned about being short euro/sterling until after Wednesday's Q1 UK GDP report, which it said could come in weaker than expected due to temporary factors. (Reuters poll consensus is for a 0.1% rise Q/Q)

- As everyone watches the FOMC outcome on Wednesday, Bank of New York Mellon's Simon Derrick highlights widespread expectations of further Bank of Japan easing and asset purchases on Friday. He reckons the economic arguments for more easing in Japan may be sound but it's worth considering whether BoJ governor Masaaki Shirakawa may want to start facing down heavy political pressure for endless BoJ easing.

- Rabobank's emerging markets team flag their concern about Poland's zloty, which has been one of the best performing currencies of the year so far. They say the zloty is a high "Eurozone beta" play, seen in the correlation of the eur/pln rate with composite euro periphery sovereign CDS spreads, and as a result will suffer if euro tensions rise further over the next month or two.

from Global Investing:

Play the mini-cycles, not the euro crisis

For all the headline attention on euro zone political heat over the next six weeks or so  (Spain is already in the spotlight, Sunday is the first round of the French presidential elections, Greece goes to the polls on May 6, Ireland votes on the EU fiscal pact on May 31 etc etc),  global investors may be better rewarded if they follow the more mundane runes of the world's manufacturing cycle for tips on market direction.

As showcased by the IMF this week, the big picture global growth story remains one of a relatively modest slowdown this year to 3.5% before a substantial rebound in 2013 to well above trend at 4.1%. Of course, there are some who think that's hopelessly optimistic and others who may quibble about the absolute numbers but agree with the basic ebb and flow.

Yet within even these headline numbers, many mini-cycles are  playing out -- especially within manfacturing, which accounts for about 20% of global GDP.  But problems in deciphering these twists and turns have been compounded over the past year or so by the impact from natural disasters and supply chain disruptions such as Japan's devastating earthquake and Thailand's floods.

Crunching the numbers  for Q1, however, JPMorgan's global economists reckon global maufacturing output hit an annualised quarterly clip of some 5.6%. Even though that's still off the pace of one year ago, it's back near levels seen in Q3 of last year before the late-year slump. Breaking that down, the United States accounted for more than a half the Q1 rebound while emerging Asian economies, benefitting most from the bounceback after Thailand's floods, zoomed at a 20% annualised rate.

However, this impressive manufacturing bounce is already ebbing again in the second quarter. The Thai bounceback looks spent and an acceleration in US inventory accumulation is now slowing output there.

Although only one part of a more complex GDP picture (we will see Q1 GDP readouts from the United States and Britain next week as well as flash April business sentiment gauges for Europe and China),  world equity markets appear to be taking a lead from the manufacturing pulse -- surging in Q1 and now cooling into April. If so, what can be said about the rest of the year?   JPMorgan at least reckons we're in for another reacceleration around mid-year, for a variety of the seasonal, inventory and disaster-related reasons already affecting the mini-cycle and with a rebound in utilities output as weather normalises stateside and in Europe.

So while Europe's ongoing sovereign debt and banking crisis continues to pose risks to the global economy, its impact ont he wider world may be getting weaker. And it's curious that a possible re-acceleration of manufacturing this Summer could come in tandem with important junctures in the euro saga itself -- namely the European Banking Authority's June recapitalisation deadline for euro area banks and also the introduction of the permanent European Stability Mechanism to shore up the rest.  Deadline-driven deleveraging and global asset sales by euro zone banks,  mercifully  slowed by the ECB's cheap 3-year LTRO in December and February,  was easily been the biggest external transmission mechanism of the euro crisis last year. Once that has passed, it's possible there may even be some financial sector relief to add a fillip to any manufacturing resurgence.

from Breakingviews:

Portugal doesn’t require Greek remedy for now

By Neil Unmack

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Portugal can avoid becoming a new Greece. There’s a strong likelihood that Lisbon won’t be able to fund itself on financial markets in the second half 2013 - contrary to the timetable agreed in the country’s May 2011 bailout plan. Yet when it turns to its euro zone partners for help, there’s a chance Portugal won’t have to force losses on its private creditors, like Greece did. Still, no one can rule out a worsening of the economic outlook that would tip it into Greek territory.

Euro zone governments have some reasons to agree to a second bailout without restructuring. So far the Portuguese government is doing a good job. It cut its budget deficit by 3.5 percentage points last year, and the International Monetary Fund reckons its 4 percent target this year is within reach. Other euro zone governments, like Spain, are struggling. A Portuguese debt restructuring would make a Spanish one more likely by stoking contagion fears. Portugal has a lower deficit than Spain, and lower government debt-to-GDP than Italy. Furthermore, Greek-style pain would break the taboo that euro governments and the ECB tried to put in place when they swore that the Greek private sector involvement would remain an exception.

Still, the country’s finances are in a fragile situation. Rising bank losses and contingent liabilities for state-owned companies could push up government debt. Austerity may prove self-defeating in the context of serious private-sector deleveraging - something the IMF worries about. Finally, the Portuguese people may reject seemingly endless austerity, especially if the structural reforms enacted by the government take too long to generate positive economic results.

If the choice is made to restructure the country’s debt in 2013 or afterwards, there will be some logic in doing it quickly. Portugal has about 107 billion euros of debt that could be haircut, equivalent to roughly 63 percent of 2013’s forecast GDP. That comes down to 49 percent if the ECB’s estimated 23 billion euros of Portuguese sovereign bonds are excluded. Another 33 billion euros of bonds come due between 2013 and 2015, reducing the haircuttable debt as time goes by. The longer Portugal waits, the smaller the benefit of a restructuring, or the more brutal it will have to be.

from John Lloyd:

For Europe, it doesn’t get better

The European crisis isn’t over until the First Lady pays, and the First Lady of Europe, Angela Merkel, cannot pay enough. She needs to erect a large enough firewall to ensure that the European Union’s weaker members do not, again, face financial disaster. That will not happen – which means the euro faces at least defections, and perhaps destruction.

The crisis had seemed to recede somewhat in early 2012, and the headline writers moved on. But it had only seemed to recede, and relaxation was premature. As Hugo Dixon of Reuters’ Breaking Views put it on Monday, “the risk is that, as the short-term funding pressure comes off, governments’ determination to push through unpopular reforms will flag. If that happens, the time that has been bought will be wasted – and, when crisis rears its ugly head again, the authorities won’t have the tools to fight it.”

But the underlying tension remains between high indebtedness in nearly all the EU countries and the need to pare back public spending without suffocating the economies. The flat, or negative, growth lines in the same countries that are indebted are likely to be made worse as demand falls and a malign cycle threatens.

Merkel commands the stage, but she is a constrained commander. She has an electorate and a parliament that has been reluctant to agree to more assistance to those whom many Germans see as architects of their own misfortune, not to be trusted to do anything other than load the burden on to the backs of hard-working Northerners.

In other parts of the Union, signs of strain now manifest themselves daily. In France, the leading candidates – President Nicolas Sarkozy and Socialist contender François Hollande – have turned inward and, in the words of a sharply worded Economist editorial, while “it is not unusual for politicians to ignore some ugly truths during elections … it is unusual, in recent times in Europe, to ignore them as completely as French politicians are doing.”

Sarkozy has transformed himself from responsible European statesman into an anti-immigrant, anti-free-trade superpatriot (and his ratings improved). Hollande, from the Socialist Party’s moderate wing, has likewise transformed, but into a “hater” of the rich. Both see strong contenders to their right and left: Marine Le Pen of the far-right Front National has faltered recently – perhaps because Sarkozy has stolen some of her clothes – but she still polls at around 14 percent. And on the left, former Socialist minister Jean-Luc Mélenchon has swung hard-left, put together a group that includes the Communist Party, and seen his support rising in the latest poll, for LH2/Yahoo, up to 15 percent so far.

Britain is not in the euro but is deeply dependent on European resurgence. Its Conservative-Liberal coalition government finds itself faced with strikes by tanker drivers – men with a capacity for squeezing a nation’s windpipe – and plunging polls. Nor is anyone else enjoying support. All the main party leaders see their ratings deep into negative territory; and in a by-election last week, the renegade Labour MP George Galloway played for and won a heavily Muslim vote in the city of Bradford, destroying a long-held Labour majority.

from Breakingviews:

Spain can’t avoid austerity conundrum

By Fiona Maharg-Bravo

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

It’s hard to get the population revved up for a general strike in a country with a 23 percent unemployment rate. Indeed, the one in Spain on March 29 - aimed at stopping the country’s recent labour reform - was relatively subdued. There is an air of inevitability about the upcoming austerity, to be outlined on March 30 in the conservative government’s first full-year budget. Too much austerity could be self-defeating and even unrealistic, but Prime Minister Mariano Rajoy doesn’t have much choice.

The scale of adjustment on the cards looks daunting. The central government has already clocked up a 2 percent deficit in the first two months of the year, against 1.3 percent in the same period in 2011. The gap is mostly explained by an acceleration of financial transfers from the centre to the regions and the state welfare system, according to Deutsche Bank. The underlying deficit increase was marginally above last year’s. The state can take some comfort that some of the tax increases announced in December will start to take effect in March.

Rajoy has already announced some of the measures, such as an increase in spending cuts at the ministries, and a freeze of civil servants’ salaries. Companies are braced for having to pay more taxes, either with the end of some deductions or through straightforward rate hikes. But concerns remain about the finances of the regions, which accounted for two-thirds of the deficit miss last year. Spain recently admitted to a budget shortfall of 8.5 percent of GDP in 2011, against its original target of 6 percent.

Economists believe it will be difficult for Rajoy to shrink the deficit to the 5.3 percent agreed for this year with the European Commission and other euro members. This looks near impossible if the government persists in its refusal to raise value-added tax. Sticking to austerity at all costs may even be self-defeating if it sends the economy into a tailspin.

But Rajoy has already burned political capital by unilaterally setting his own deficit target and taking what was perceived as a defiant stance by his euro partners and the European Central Bank. There will be no easy way out of this conundrum.

from Photographers Blog:

Surviving rather than living

By Cathal McNaughton

“My wife thinks I don’t do enough but I’m doing everything I can. I work day and night. I’m trying to work my way out of this,” olive farmer Dimitris Stamatakos told me as he took a break from stacking wood at his small-holding in the village of Krokeae in the Peloponnese area of Greece.

During the boom years Dimitris, 36, made a comfortable living from the 1,700 olive trees on his seven acres of land – today, due to rising costs and higher taxes, his olive crop yields just 50 per cent of what it once did and to make ends meet he toils endlessly at odd jobs.

Selling firewood, hiring out his tractor and even hiring himself out as a laborer to his neighbors are just a few of the ways he makes the extra euros he needs to support his wife Voula and their two young boys, three-year-old Christopher and one-year-old Elias.

Dimitris’ work ethic is matched only by his hospitality. He insisted I join him for a glass of Tsipouro - the potent local brandy - which he served up with his home grown olives as he told me how he is trying to keep his head above water.

from Breakingviews:

Now prepare for the next crisis

By Edward Hadas

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The Tale of Hellenic Foolishness appears to be over. A mix of writedowns and new money, with more of the latter, has come to the rescue. Greece’s chapter in the financial crisis epic reads much the same as the prologue on subprime mortgages – too much foolish lending ends in a sudden stop that threatens to destroy global finance, until finally there’s a political rescue.

The story continues. The financial system remains distorted and dangerous. While banks are better capitalised and perhaps more prudent, policy interest rates are abnormally low and government deficits and commodity prices are abnormally high. The U.S. trade deficit, which fell from 5.1 to 2.7 percent of GDP during the crisis, is back up to 3.6 percent of GDP – adding $560 billion a year to the wild flow of funds around the world’s capital markets.

Where does the saga go from here? Another primarily financial episode, like the subprime debacle, wouldn’t be fantasy. The obvious plotlines are a creditors’ run from the United States or a shortage of buyers of Japanese government debt. “Oil Flameout” – a sudden spike followed by a disastrous fall – is another convincing scenario. Such problems can be solved by the same force which caused them, cheap money. After almost four years of experience, governments know the rescue drill.

Another euro zone-style financial-political crisis would pose greater challenges. Many nations are vulnerable to sharp changes in the prices of commodities and financial assets, or in the availability or cost of credit. The next chapter could be “Russia Topples” or “China Discovers the Downside of Capitalism”. “Euro Redux” is still a risk. “New American Revolution” is less likely, although self-defeating populist economics are appealing in a land where many mortgages remain underwater and unemployment is still high.

It’s not possible to jump to the last page to see how the story ends. But there’s a title for an epilogue about a world that uses finance to solve the problems that finance itself creates: “Inflation Everywhere”.

from Breakingviews:

Euro zone first default gives few reasons to cheer

By Neil Unmack

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

It could have been worse: that’s the best thing to be said about the Greek debt swap. The euro zone’s first restructuring will not be chaotic. But it has done away with the pretence that a euro zone sovereign’s signature is golden. And Greece will still struggle with a heavy debt load.

The good news is that enough bondholders agreed to the Greek plan to allow Athens to force losses on the recalcitrant private creditors through collective action clauses. Some owners of securities subjected to non-Greek law are holding out, but the hit rate will be at least 95.7 percent. That should allow the second Greek bailout in 18 months to proceed. The deal will trigger a payout on credit derivatives. A failure to trigger would have compromised the credibility of other sovereign default swaps, which are important hedging tools for banks.

Still, the restructuring has costs. Arguably, it wasn’t fair. Private creditors have been punished for lending recklessly, but public-sector lenders have got off lightly even as this second bailout was the proof that they had bungled the first one. The European Central Bank’s holdings of Greek bonds have been protected; euro zone governments have not haircut their loans, although they did agree to charge lower interest rates. This unequal treatment will weigh on the prices of bonds sold by other weak states. More broadly, the euro zone must now cope with a world where sovereign creditworthiness has been impaired, affecting borrowing costs across the region.

Even for Greece, the restructuring isn’t particularly good news. Despite wiping about 100 billion euros from its debt pile, Greece will still have debt equivalent to 168 percent of GDP next year – which will only come down to 120 percent by 2020, at least if all goes according to plan. That will weigh on Greece’s growth and its population’s appetite for reform.

The new 30-year bonds issued under the restructuring could be expected to trade at about 28 percent of face value, according to Breakingviews calculations, assuming a discount rate of 12 percent. The current price in the unofficial “grey” market is about 20 percent, suggesting markets expect more losses. After the biggest sovereign restructuring in post-war history, Greece is only at the end of Act 1.