Archive

from MacroScope:

Can Greek public opinion be turned?

So we’ve got the fresh Greek elections we expected and markets, despite the inevitability that we would get here, have reacted with some alarm. European stocks have shed  around 1 percent, and the harbour of German Bunds is pushing their futures price up in early trade. The Greeks will try to form a caretaker government today to see them through to elections expected on June 17.

The key question is whether the mainstream parties can mount a convincing campaign second time around, playing on the glaring contradiction in SYRIZA’s position (no to bailout, yes to the euro) and essentially turning the vote into a referendum on euro membership, which the overwhelming majority of Greeks still support. Don’t count on that. SYRIZA remains ahead in the polls. To be able to pull it off, PASOK and New Democracy will need some help from Europe. There have already been hints from Brussels that if a pro-bailout government is formed, Athens could be given some leeway on its debt-cutting terms. But equally other voices are saying there is no more room for manoeuvre.

France's Francois Hollande used his presidential debut to frame help for Greece within his push for a European growth strategy last night, saying he hoped that could also foster a return to prosperity there. He and Germany's Angela Merkel are due in the United States for a G8 summit at the end of the week where doubtless they will come under heavy pressure to make sure Greece doesn’t bomb out of the euro zone or, if it does, that the effect is contained. Easier said than done. Given a Greek euro exit would probably require rapid concerted reaction from the EU, IMF (to shore up Spain?) and the world’s big central banks (remember the global monetary policy response after the collapse of Lehmans?), planning for that could well be bubbling below the surface at the G8.

IMF chief Christine Lagarde said last night that it was important to be technically prepared for the possibility of Greece leaving the euro zone while Finland’s prime minister said Greek euro exit would not cause the financial mayhem seen in 2008.

As we’ve said before, Greece has some leverage. The IMF, ECB and euro zone governments are holding a lot of Greek debt so have an incentive to keep the  show on the road or face heavy losses if there is a hard default. Of Greece’s 250 billion-plus euros of debt, nearly 200 billion is now held by those public bodies, most of it by the ECB, which could need recapitalizing after that sort of hit, something that would fall back on euro zone governments. It is also hard to see how Europe could avoid propping Greece up even if it did leave the currency club. The calculation for euro zone leaders is whether pouring good money after bad is more or less palatable than taking a big loss on their Greek debt holdings.

On the growth strategy, there are hints that Spain will get more time to hit its 3 percent of GDP budget target, so why not something similar for Greece? PASOK leader Venizelos, the man who negotiated the bailout and who was humiliated in the election 10 days ago, has pressed for three years rather than two to make the cuts required by Greece’s programme. If he got stronger signals from euro zone partners that something like that could happen – and persuaded the electorate that this is the only way to avoid euro exit  -- it’s possible that he and New Democracy leader Samaras could do better second time around. The problem for the markets is that while you can take a reasonable stab at how politicians might act, it’s much harder to read a battered electorate. So they are in for a rocky month.

What is undeniably true is that the piecemeal European growth measures announced so far to revive moribund economies don’t amount to a hill of beans.

from MacroScope:

Greek tragedy

Greece is stumbling inexorably towards fresh elections which polls suggest will give the anti-bailout far left a stronger grip on power. Last ditch talks aimed at creating a unity government will continue under the aegis of the president today but the leader of the radical leftist SYRIZA has said he will not turn up. Alexis Tsipras says he wants Greece to stay in the euro but will rip up the bailout agreement. Go figure. This morning the more moderate left party has said it won’t take part in a government lacking SYRIZA.

A big question is whether the mainstream parties can mount a convincing campaign second time around, playing on the glaring contradiction in SYRIZA’s position and essentially turning the vote into a referendum on euro membership, which the overwhelming majority of Greeks still support. Don’t count on that.

Two ECB policymakers --  Honohan and Coene – were out over the weekend talking about the possibility of a Greek euro exit: there goes another taboo. Policymakers must be running through the hard default and exit scenarios now. We need to be asking.

As we’ve said before, Greece has some leverage. The IMF, ECB and euro zone governments are holding a lot of Greek debt so have an incentive to keep the  show on the road or face heavy losses if there is a hard default. Of Greece’s 250 billion-plus euros of debt, nearly 200 billion is now held by those public bodies. It is also hard to see how Europe could avoid propping Greece up even if it did leave the currency club. The calculation for euro zone leaders is whether pouring good money after bad into Greece is more or less palatable than taking a big hit on their Greek debt holdings.

Greece will obviously loom large over this evening’s meeting of euro zone finance ministers in Brussels. But so will Spain. There is talk of Madrid getting some leeway on its deficit-cutting targets after the European Commission predicted on Friday they would be missed. But first it will have to present a more credible 3-4 year plan on how it will get there. So don’t expect anything definitive today. Spain is grappling with its bad bank debt problem but the 84 billion euros it has told banks to put aside still looks shy of what’s needed. Either government or euro zone money is likely to have to come to the rescue at some point. So far banks have responded with plans that do not require state aid, apart from Bankia which was essentially nationalized last week.

If Spain is cut some slack then why not Greece? (maybe because it has been bailed out twice). Venizelos, the finance minister who negotiated the second bailout, has suggested Athens gets three years instead of two to produce the cuts demanded in its loan programme. If that happened, Portugal and Ireland would presumably demand better terms for their bailouts but it’s not impossible – we’re clearly into policymaking directed at the lesser evil here.

A hefty defeat for Angela Merkel in a key state election on Sunday may not help her bend the rules to keep Greece going. But as regards a euro zone growth strategy -- a hot topic this week with Francois Hollande rushing to Berlin for a debut visit -- the fact the centre-left SPD, who have argued against austerity for austerity's stake, cleaned up in North Rhine-Westphalia is interesting. Another prominent growth proponent, Mario Monti, said on Sunday that Italy's social fabric is being torn by recession and tensions are growing among its citizens. It looks like there is a growing resolution that the end-June EU summit must come up with more profound growth measures than anything currently on offer. More time to meet deficit targets looks like the obvious option.

from Breakingviews:

Euro zone carry trade has limited shelf life

By Neil Unmack and Fiona Maharg-Bravo

The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

The carry trade is alive and well in Spain and Italy. Banks are loading up on sovereign debt, thanks to the wave of liquidity from the European Central Bank’s cheap three-year loans. But local lenders can’t fund Madrid and Rome indefinitely, and with markets still dysfunctional, money could run out sooner than expected.

Spanish and Italian banks borrowed 220 billion and 140 billion euros of new money, respectively, under the ECB’s cheap three-year facilities. So far, they have mainly used the cash to replace privately-held bonds that are falling due, or to buy government debt. Spanish banks have bought 85 billion euros of sovereign paper between December and April, while Italian lenders have propped up the state to the tune of 77 billion euros. That’s allowed the two countries to carry on borrowing when international investors are scarce.

In theory, this could carry on for a while. RBC estimates Spanish banks have 82 billion euros of ECB cash left over - double the 41 billion euros that Madrid still needs to raise this year. As some investors - particularly domestic ones - are likely to swap maturing government bonds for new ones, Spain may only need 20 billion euros of new money. Italian banks, meanwhile, have 53 billion euros of ECB firepower, according to RBC. If domestic investors play ball, the government’s funding gap this year is around 70 billion euros.

Moreover, despite their recent splurge, banks have room to increase their holdings. Sovereign bonds account for just 7 percent of total balance sheet assets in Spain and 7.8 percent in Italy. In 1999, the share in both countries was over 10 percent. In Japan, it’s 23 percent.

However, larger banks like Santander, BBVA and UniCredit are unlikely to increase their sovereign exposure. Smaller banks face less scrutiny from markets, but also have less spare liquidity. Besides, banks have more pressing needs: Spanish lenders must refinance about 65 billion euros of funding this year, and there’s little prospect of them being able to tap wholesale markets.

from MacroScope:

The end of austerity? Not likely

It was Bill Clinton who, after the 2000 U.S. election was thrown into turmoil by Florida's hanging chads, said the American people had spoken but it was going to take a little time to work out what they had said. No such dilemma in Greece. A plague on both your houses was the message for the traditional ruling parties PASOK and New Democracy, a result that makes a stable government look a remote possibility and puts a very real question mark over its bailout programme.

Today, the largest party New Democracy will try to form a coalition. Given what they've said, the left-wing Left Coalition which leapfrogged PASOK into second place cannot be part of a government committed to the bailout terms so it looks like the two traditionally dominant parties -- two seats short of an overall majority between them -- must seek support from elsewhere or face fresh elections which could well give an even more fractured result. One thing worth noting is that even the resurgent anti-bailout parties mostly say they want to stay in the euro zone so maybe there's soom room for negotiation.

The euro has dived to a three-month low, Bund futures have posted yet another record high and European shares are down so we're right back in fear mode.

Two big questions flow from all that: 1. Could this vote, and socialist Francois Hollande's victory in France, shift the growth/austerity debate? 2. Does Greece, even its possible euro exit, still have the power to spread damaging contagion to the rest of the euro zone?

On the growth front, the answer is only up to a point because Berlin and the European Central Bank -- and the markets -- won't wear anything that will dilute debt-cutting programmes much, whatever the more friendly rhetoric suggests. Italian premier Mario Monti, a man desperate for growth, talked to Hollande, Germany's Angela Merkel and Britain's David Cameron among others after the elections last night, presumably to push that agenda and the argument is gaining force.

EU economics chief Olli Rehn chipped into the growth debate over the weekend, suggesting there is some leeway to temper debt-cutting drives in order to leave scope for growth. But again, details were elusive. Rehn also said those countries under the  microscope had to convince the markets and policymakers of their capacity to put their fiscal houses in order. This sounds rather like having your cake and eating it, or at least reaffirms what we've been saying -- that there may be some limited fiscal wiggle room, but only as much as the markets will allow, which is not much.

So the growth strategy stills seems to rest on structural reforms (which will take years to bear fruit), plus reconfiguring some EU funds and a beefed up European Investment Bank. Those who really count -- Merkel and Draghi at the top of the list -- are talking up growth measures while insisting the austerity drive must not be dimmed. The markets would probably respond well to stimulus which did not fundamentally undermine debt reduction. But that's some trick. And what's on offer so far will not do the trick. Will something more profound be cooked up for the end-June EU summit?

from MacroScope:

Spotlight back on Spain

After a May Day holiday lull, the euro zone roars back into life with Spain facing a game of chicken with the bond market as it auctions three- and five-year bonds and the ECB holding its monthly policy meeting in Barcelona, which lends it a certain poignancy.

Spanish yields will rise sharply compared with the previous equivalent sale and the auction is the first since S&P’s two-notch downgrade of Spain’s credit rating last week. Spanish banks, flush with three-year cash despite their horrendous bad loans problem, continued to load up on Spanish government debt in March while international investors backed off. Whether they will continue to do so is a very open question.

Three- and five-year yields on the secondary market are more than a percentage point higher than when this maturity was last sold earlier in the year. But 2.5 billion euros is a modest amount to shift and Spain has already sold half its debt issuance target for the year in the first four months.

France will also hold a bond auction, three days before its presidential election run-off. Mario Draghi pulled a surprise rabbit out of his hat last week when he added his voice to calls for a European growth strategy. With no policy change in the offing from Barcelona anything he says about that will be closely scrutinized although it already seems that he and his colleagues don’t envisage the ECB doing much to help beyond keeping policy loose. What is being talked about is some extra lending power for the European Investment Bank and some reallocation of existing EU funds, along with much-heralded structural reforms. That may help a bit but it’s nothing like enough to turn the euro zone economy around. With monetary policy already ultra-loose, that would require serious fiscal stimulus.

Euro zone leaders, led by Merkel and Schaeuble, have made it quite clear they won’t tolerate any let-up in the austerity drive to cut debt. Nor are the markets likely to accept a big shift on that front.

It seems pretty clear that things would have to get a lot worse for the ECB to resume its bond-buying programme, let alone launch a third round of three-year money creation, even though it will witness the pain in Spain first hand.

In fact, its harder core members may be more focused on 6 percent-plus wage demands in Germany which the powerful unions are threatening to strike over. Having said that, the latest survey evidence suggests the euro zone economy is resolutely heading south with the pain particularly acute in Spain and Italy.

from MacroScope:

Tumultuous euro zone week

A week where every facet of the euro zone debt saga will come from all angles.

The major events are the French presidential run-off and Greek general elections on Sunday, May 6.   In the former case, a likely socialist Francois Hollande victory could cause some market jitters given his rhetoric about the world of finance. But we’ve looked at this pretty forensically and actually there may not be much to scare the horses. Yes he is making growth a priority (but even the IMF is saying that’s a good idea) yet his only fiscal shift is to aim to balance the budget a year later than Sarkozy would. And, contrary to some reports, he is not intent on ripping up the EU’s new fiscal rules. And of course, the bond market will only allow so much leeway.

If the two main Greek parties – PASOK and New Democracy – fail to win enough votes to govern together, they may have to turn to a fringe anti-bailout party which would put a big question mark over Athens’ ability to stick with the austerity terms demanded by its international lenders.

Even if fears about a hard Greek default or even euro exit result, the threat of contagion looks far smaller. With creditors already having taken a massive haircut, most non-Greek banks completely out or at least having written down anything they hold, a 500 billion euros rescue fund shortly in place and the IMF raising an extra $430 billion of its own, the power Greece has to start a domino effect in the euro zone is very much diminished.

Netherlands’ fractured political parties have managed to put together a budget deal in time to present it on deadline to Brussels on Monday but Spain remains far more a source of concern. Downgraded again, its borrowing costs have soared since the government loosened its 2012 deficit target in March. Data just out shows the Spanish economy has succumbed to recession again. Madrid will hold a bond auction on Thursday, as will France.

As we’ve been saying for a while, hopes that the ECB cavalry will ride to the rescue are wide of the mark, until and unless the crisis takes a distinct turn for the worse.

The European Central Bank holds its monthly meeting in Barcelona on Thursday. No policy change is expected and Mario Draghi will doubtless re-emphasise that by creating more than a trillion euros of three-year money, the ECB has bought time for governments and banks to put their own houses in order. There will be a strong focus on his latest call – for a “growth compact” – though it seems to focus mainly on structural reforms and some capital spending out of EU funds, i.e. nothing that the ECB has to get involved in.

from Lawrence Summers:

Austerity has brought Europe to the brink again

Once again European efforts to contain crisis have fallen short. It was perhaps reasonable to hope that the European Central Bank’s commitment to provide nearly a trillion dollars in cheap three-year funding to banks would, if not resolve the crisis, contain it for a significant interval. Unfortunately, this has proved little more than a palliative. Weak banks, especially in Spain, have bought more of the debt of their weak sovereigns, while foreigners have sold down their holdings. Markets, seeing banks holding the dubious debt of the sovereigns that stand behind them, grow ever nervous. Again, Europe and the global economy approach the brink.

The architects of current policy and their allies argue that there is insufficient determination to carry on with the existing strategy. Others argue that failure suggests the need for a change in course. The latter view seems to be taking hold among the European electorate.

This is appropriate. Much of what is being urged on and in Europe is likely to be not just ineffective but counterproductive to maintaining the monetary union, restoring normal financial conditions and government access to markets, and re-establishing economic growth.

The premise of European policymaking is that countries are overindebted, and so unable to access markets on reasonable terms, and that the high interest rates associated with excessive debt hurt the financial system and inhibit growth. The strategy is to provide financing while insisting on austerity, in hopes that countries can rein in their excessive spending enough to restore credibility, bring down interest rates and restart economic growth. Models include successful International Monetary Fund programs in emerging markets and Germany’s adjustment after the expense and trauma of reintegrating East Germany.

Unfortunately, Europe has misdiagnosed its problems in important respects and set the wrong strategic course. Outside of Greece, which represents only 2 percent of the euro zone, profligacy is not the root cause of problems. Spain and Ireland stood out for their low ratios of debt to gross domestic product five years ago, with ratios well below Germany’s. Italy had a high debt ratio but a very favorable deficit position. Europe’s problem countries are in trouble because the financial crisis under way since 2008 has damaged their financial systems and led to a collapse in growth. High deficits are much more a symptom than a cause of their problems. And treating symptoms rather than underlying causes is usually a good way to make a patient worse.

The cause of Europe’s financial problems is lack of growth. In any financial situation where interest rates far exceed growth rates, debt problems spiral out of control. The right focus for Europe is on growth; in this dimension, increased austerity is a step in the wrong direction.

Systematic comparisons suggest that when economies are demand-constrained and safe short-term interest rates are near zero, policy measures that reduce the deficit by 1 percent have a multiplier of 1 to 1.5 – implying that a 1 percent reduction in a country’s ratio of spending to GDP or an equivalent tax increase reduces its GDP by 1 to 1.5 percent. Essentially, cutting deficits will have a disproportionately adverse effect on GDP because the multiplier is larger than 1 on the growth-reduction side of the equation. This means that austerity measures at the national level are likely to be counterproductive in terms of creditworthiness. Fiscal contraction reduces incomes, limiting the capacity to repay debts. It achieves only limited reductions in deficits once the adverse effects of economic contraction on tax revenue and benefit payments are accounted for. And it casts a shadow over future growth prospects by reducing capital investment and raising unemployment, which inevitably takes a toll on the capacity and willingness of the unemployed to work.

from Breakingviews:

Draghi’s growth babble is no retreat on austerity

By Pierre Briançon

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

Is it still possible to mention the word “growth” without becoming a hostage in the French presidential campaign? Mario Draghi, the European Central Bank president, has been hijacked by the French socialist party because he has called for a euro zone “growth compact”. Presidential candidate François Hollande sees it as a sign that his ideas are gaining ground. But Draghi’s statement to the European parliament wasn’t a seismic shift. More important, what he means by growth compact has nothing to do with what Hollande plans to do if elected.

The upcoming conflict within the euro zone is not, thankfully, whether growth is good or not. Everyone agrees it is. There is also unanimity on the need for fiscal discipline. What sets Hollande on a collision course with Germany, the ECB and most of France’s euro zone partners is his belief that growth will come from the rest of the world while France avoids the painful domestic reforms which are underway in most of Europe.

France has the highest hourly labour costs of any major European economy, according to EU statistics, updated this week. They have risen 39 percent in the last decade, twice as fast as in Germany. True, that data doesn’t take into account productivity, which is high in France, but the deterioration in the current account shows the country’s competitiveness has deteriorated.

If Hollande keeps thinking that this is not a problem, or if he thinks it is but feels obliged to lie to the French about it, there’s no way to find common ground with Mario Draghi. Even though the expression “growth compact” may sound new, there’s nothing there that hasn’t been said, over and over, by central bankers: governments must reform, and the longer they wait, the more painful it will be.

Euro bonds, big investment programmes and German stimulus would all help, but they will not spare France the pain of reform. If Hollande the candidate keeps ignoring that reality, Hollande the president will hit the wall head first.

from MacroScope:

ECB to the rescue? Hold your horses

ECB policymakers from Mario Draghi down will come at us from all angles today. Expect a united front on the main theme of the moment; calls for it to consider yet more liquidity operations essentially creating money and/or resuming its government bond-buying programme. That call was first heard at the IMF spring meeting over the weekend and the ECB president’s response could hardly have been clearer, saying: “None of the advice of the IMF has been discussed by the Governing Council, in recent times at least".

Since then a number of his colleagues have followed up. The message: they are looking more to inflation now and banks and governments have to put their own houses in order after the ECB gave them time with its colossal three-year money-creating exercise. The ECB's man in Spain, Gonzalez-Paramo, is already out this morning saying Spain will not struggle to meet its debt issuance target this year despite its rising yields.

The ECB will, of course, act if the crisis drives Europe right back to the brink, it's mandate will pretty much demand it at that stage but we’re not anywhere near there yet – contrary to what many in the markets believe.

That things are not good is not in dispute.

The Netherlands pushed itself further into the mire yesterday when its opposition parties refused to back an austerity budget which the government collapsed over earlier in the week. That leaves the prospect of the Dutch failing to present the EU with a budget plan by an April 30 deadline and, more seriously, a period of policy paralysis stretching to elections which will not be held until September.

That vote is also quite likely to usher in an administration opposed to the austerity drive, a theme that is gathering pace within the euro zone, with socialist Francois Hollande, a warm favourite to take the French presidency next month, staking out similar ground and also suggesting the ECB should adopt pro-growth policies.

However, if there is any shift away from debt cutting – and as the IMF says, that is eminently sensible given many of these countries will drive themselves further into recession which would likely add to debt piles – it will be marginal. German opposition and the bond market will only allow a small shift in emphasis.   The lessons are already there for all to see. Italy pushed back its balanced budget goal by a year, a small shift, and investors were not alarmed. Spain substantially cranked up its 2012 deficit target and has been slaughtered by the bond market ever since, to the point where many now expect it to need a bailout.

from MacroScope:

Roubini takes on the ECB

It was fun to watch. Nouriel Roubini, NYU economist and crisis personality, was one of just five carefully selected individuals at a large gathering in the International Monetary Fund HQ1 building’s towering atrium who actually got to ask questions of the policymakers on stage.

Roubini was characteristically biting in his critique of conventional orthodoxy, singling out the European Central Bank for not having done enough to stem the euro zone’s two-year financial crisis. He challenged the notion that the ECB is powerless to boost growth further, suggesting -- to the clear discomfort of some policymakers in the room -- that measures to weaken the currency could provide a badly-needed boost to exports:

I saw that on the panel there are four central bankers and the panel is about fiscal policy and sovereign debt. So the natural question is then to think maybe about what could be the contribution of central banks in resolving sovereign debt issues. Now, one simple answer would be to just monetize very large budget deficits and I understand why a central bank would say that’s a no-no.

But there’s a more subtle argument and it’s the following one: we know that while fiscal austerity is necessary, in the short-run, as even Christine Lagarde said and the IMF’s work suggests, that has a net recessionary effect on the economy. You’re raising taxes, you’re reducing transfer payments, you’re reducing government spending, so you’re reducing disposable income, you’re reducing aggregate demand. It makes the recession worse and you can get a vicious circle. Not only do you have deleveraging of the public sector but the raising of taxes and cutting of transfer payments induces also deleveraging of the private sector.

So if domestic demand is going to be anemic and weak in this fiscal adjustment because of private and public sector deleveraging you need net exports to improve to restore growth. That’s what happened in emerging market crises. But in order to have an improvement in net exports you need a weaker currency and a much more easy monetary policy to help induce that nominal and real depreciation that is not occurring right now in the euro zone. That’s one of the reasons why we’re getting a recession that’s even more severe. So, can’t we think of monetary policy as helping to induce the change in relative prices that’s necessary to have a restoration of growth if domestic demand is weak through net export improvements?

Roubini was not alone in his critique either, with the ECB coming under pressure from the IMF itself to lower rates further.

ECB Vice President Vítor Constâncio responded by stressing the institution’s price stability mandate as well as the difficulties of synchronizing policy for a group of nations growing at different speeds:

We have only one monetary policy for the average of the euro area. Headline inflation is now at 2.7 (percent). We anticipate, and we have reasons to trust the forecast that inflation in the euro area will be below 2 at the beginning of next year. Nevertheless it’s about 2. Even if you consider core inflation, it’s now at 1.6 – so it’s clearly not in any way a deflation risk. And this would be the reason for us to have a different monetary policy than the one we have now, because that would be directly connected with our mandate regarding price stability in both directions. But that’s not the case right now.

So your implicit view, or recommendation if I may draw that from your question, really would fit much better, even appropriately, with the mandate of the Fed but it’s not what we have in the ECB.

Nevertheless we are doing a lot in view of the situation that inflation expectations are very firmly anchored. That has allowed us to do lots of things. We rely and trust that in the present situation with a weak economy we can be sure of complying with our primary objective so we can do other things and we have done that – but not what you hinted at.

Bank of France Governor Christian Noyer, who was hosting and moderating the event, had spoken about that very same subject earlier during the panel discussion. Like Constâncio, he argued markets should not expect central banks to shoulder too great a burden: