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from MacroScope:

More Greek elections?

Attempts to form a Greek coalition government appear to be running into the sand with no one prepared to dance with the two mainstream parties, New Democracy and PASOK, raising the probability of a fresh round of elections with all the uncertainty that will entail. The far-left Socialist Coalition will have a stab at forming an administration today but doesn't really have the numbers to do it.

The only plan that looks like it offers a glimmer of hope is that put forward by PASOK leader Evangelos Venizelos. He is after a "pro-European" coalition and has pledged to spread the cuts Greece has been ordered to make under its bailout programme over three years not two. If a burst of realpolitik every takes hold in Athens (and it's worth noting that nearly all the parties say they want to stay in the euro), that could just be enough to get others on board. BUT, Venizelos would then have to go to Brussels to persuade the EU to go along with this relaxation of its targets and, on and off the record, officials lined up yesterday to say there was no prospect of that happening. And his PASOK was the party that was most badly humiliated at Sunday's election so it's hard to see how it has a mandate to rule the Greeks, a majority of whom voted firmly against austerity, even it is in a broad coalition.

So new elections next month are likely which leaves a very compressed timeframe and who knows what political landscape will result second time around. The EU/IMF/ECB troika is supposed to return in June and can't negotiate on the next bailout tranche if there is no government. In any case, Athens is supposed to find 11 billion euros of extra cuts as part of the aid programme and none of the parties are in a position to do that as things stand.

One of the burning questions is whether Greece's euro zone partners are in any mood to cut it some more slack -- the atmospherics a few months ago when the second bailout deal dragged on and on suggested they certainly weren't then. And even if they were, they would have to take into their calculations that any relaxation by Greece would presumably be demanded by Ireland and Portugal too, which could put markets back on alert.

However, the reaction yesterday -- with stocks ending well up on the day -- suggested that some markets have either bought into the theory that the contagion threat posed by Greece is significantly diminished (see yesterday's note for reasons) or that they think that the euro zone will somehow muddle through again. Safe haven Bunds have ticked up at the open and European stocks look set to open flattish so not much to go on there.

Either way, the bigger picture is that Spain remains far more pivotal. The government's move to clean up troubled Bankia could signal it is finally getting serious about tackling its financial sector, which is it's main problem. Sources say the state will lend 7-10 billion euros. The less encouraging aspect is that the government appears to be saying that won't land on its deficit because it will be loaned at commercial rates -- the sort of accounting sleight of hand that has got investors' hackles up in the past.

from MacroScope:

Europe in recession – an interactive map

Spain has become the latest European country to slip into recession joining the Belgium, Cyprus, The Czech Republic, Denmark, Greece, Italy, The Netherlands, Ireland, Portugal, Slovenia and the United Kingdom.

Click here to view an interactive map.

*Updated to include Romania and Bulgaria

from Global Investing:

Hungary can seek IMF aid now. But can it cut rates?

The European Union has given Budapest the green light to seek aid from the IMF. (see here)  In fact, the breakthrough after five months of dispute does not let Hungary completely off the hook  -- to get its hands on the money, Viktor Orban's government will have to backtack on some controversial recent legislation, starting with its efforts to curb the central bank's independence.  It remains to be seen if Orban will actually cave in.

But markets are reacting as if the IMF money is in Hungary's pocket already. There have been sharp rallies in Hungarian dollar bonds,  CDS and currency markets (see graphic below from Capital Economics). The Budapest stock market has posted its best one-day gain since last November while the yield on local 10-year bonds have collapsed almost 100 bps. Hungarian officials are (a bit prematurely)  talking of issuing bonds on world markets.

What investors are hoping for now is a cut to the 7 percent interest rate. Hungary's central bank jacked up rates by 100 bps in recent months to defend the forint as cash fled the country. Now there is a chance those rate rises can be reeled back in. After all, the moribund economy could really use a dash of monetary easing. Thanasis Petronikolos, head of emerging debt at Baring Asset Management has been overweight Hungary and  recalls that after 2008 crisis, the central bank was able to quickly take back its 300 bps of currency-defensive rate hikes.

In the aftermath of this, the central bank may be prompted to cut short term interest rates. If the risk premium comes down a lot, the central bank may feel that 7 percent interest rates are not justified. I’m expecting them to at least take this 100 bps back assuming they can reach an agreement with the IMF.

Hungary's FRAs (forward rate agreement), are still pricing slightly higher short-term interest rates and have not yet reacted to the shifting picture. Many urge caution however on the rate cut expectations, noting that Orban and the IMF may struggle to reach common ground and the central bank will want to see money on the table before it actually acts.

Petronikolos is right in that the economy is moribund, credit growth has slumped and there is a big output gap. But headline inflation is running at 5.5 percent, well above the central bank's 3 percent target, due to an increase in sales tax.  Sandor Jobbagy, at CIB Bank in Budapest is one analyst who says inflation risks have forced him to push back the date of likely interest rate cuts. 

from Breakingviews:

EU bonus assault would lead banks astray

By Chris Hughes

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

Europe’s urge to set a bonus-to-salary ratio has always looked misguided. Yet Brussels’ position is hardening. The latest thinking seems to be that bonuses should never be more than 100 percent of base pay. There’s no doubt that investment banking still has a problem with the way it rewards staff. But fixing bonuses in this way is clearly the wrong solution.

Doubtless, a political desire to bring down overall pay levels lies behind the moves. But it is naïve to think that a 1:1 ratio will achieve this. Banks would respond by jacking up base salaries - as they have done already, following pay curbs introduced in the wake of the financial crisis. Moreover, higher salaries mean higher fixed costs. That reduction in flexibility would be stifling in an industry as cyclical as banking. Pay is banks’ single biggest operating expense.

It is rarely wise to force any sector to pay staff in a uniform way. Higher operating costs won’t help banks rebuild capital faster. Implementation would be chaotic if changes were imposed overnight. There would also be distortions: the rules would apply to European Union-domiciled banks globally, but only to the EU-branches of non-EU firms. Either way, the City of London would be hit hard. An outright cap on pay might even be anti-competitive.

Given these manifest snags, why has the industry has been so ineffective in killing the idea? Because it hasn’t come up with an alternative. Worse, many banks have persisted in making provocative pay awards, while national regulators have been inconsistent in applying existing bonus reforms.

It is an absurd situation. Europe is urgently demanding that some member states foster flexible labour markets, while a growing faction within the European Commission and European Parliament want the opposite in financial services. Meanwhile, the fundamental problems surrounding pay go unaddressed: weak competition fuels excess profits and, in turn, excess rewards; the division of profits between staff and shareholders is unbalanced and may be unfair.

from The Great Debate UK:

A two-speed economy for Europe’s youth

By Kathleen Brooks. The opinions expressed are her own.

A new dimension to the currency crisis is upon us. First there was the two-speed growth – with richer, predominantly Northern European economies performing well while the weak south was on the cusp of recession. But in recent months an even more worrying divide has started to emerge in youth unemployment.

In Spain the number of under 24-year-olds out of work is 50 percent, in Italy nearly a third of young people are without a job and in France the figure is a quarter.

However, in Germany youth unemployment is expected to sink to record lows over the coming months and is currently well below 8 percent.

If you are a young person in Germany your prospects for work and the future are brighter than they have been for generations. But for their peers in Spain things have never been worse.

So what is Germany doing right and can Spain learn a few lessons? In an article written for the Centre for European Reform, John Springford lays the problem out clearly. In EU countries where rates of unemployment are high levels of participation in higher education and vocational studies is approximately 40 percent. In Germany, Norway, the Netherlands, Denmark and Finland, where youth unemployment is fairly low, rates are closer to 60 percent in some cases.

Education and training is key to reducing youth unemployment. Not only does it help deal with young people when jobs are not plentiful, but it also boosts skill levels and could increase productivity in the long-term while also avoiding a “lost generation” of young adults who become reliant on benefits.

from MacroScope:

This week in the euro zone

A new quarter dawns and although a holiday-shortened week isn’t likely to see dramatic investment decisions taken, the burning question is whether the strong ECB-fuelled rallies of the first three months of the year can continue. The consensus so far is yes, but at a more modest pace.

Markets will pick through the details of the Spanish budget and the euro zone’s decision on increasing the capacity of its firewall. Implementation risk in the first case, and shallow ambition in the second leaves scope for disappointment.

The standout events of the week are the policy meetings of the European Central Bank and Bank of England. No policy changes will result but within the former at least, there is growing internal debate about the long-term consequences of creating a trillion euros of three-year money which no doubt prevented a credit crunch, but according to monetarist theory at least, will inevitably fuel future inflation. There is also the conundrum of creating banks forever reliant on central bank support rather than being able to stand on their own two feet and start lending to each other again.

Bundesbank chief Jens Weidmann has been leading a push by a group of ECB policymakers for the bank to prepare for a shift to exit mode just a month after it completed the second of the lending operations. His ECB boss, Mario Draghi, is more relaxed and it is highly unlikely that the ECB will change course for several months yet and quite possibly not this year.

That applies in spades to the Bank of England. BoE Governor Mervyn King sat firmly on the fence last week, saying he did not know whether more QE would be required in Britain or not. King illuminated the other common theme coming from central bankers, saying the onus was firmly on the politicians now. The major western central banks seem to be in a holding pattern, disinclined to provide yet more stimulus yet viewing their economies as far too fragile to hit the policy reverse switch.

For investors pondering whether they could be derailed by a burgeoning economic slowdown, euro zone and UK purchasing managers’ indices – which have a strong correlation with GDP – will be a must-watch as will equivalent reports from China. Spain will hold a pre-Easter bond auction. The glut of ECB money has helped Italian and Spanish debt sales go down a storm in the first quarter of the year – banishing the fear about their refinancing mountains – and that effect is likely to persist for some time yet, though not forever.

The ECB’s dramatic intervention and the debatable move by euro zone leaders to create a more potent rescue fund from mid-year buys time, but no more than that, for governments to push through structural reforms to make their economies more competitive and balance the need to cut debt while not snuffing out growth, a balancing act that has not been achieved so far. Until that is done, the underlying fault lines remain.

from MacroScope:

Today in the euro zone – a blizzard of bailout numbers

Brace yourself for a blizzard of numbers.

EU finance ministers gathered in Copenhagen are poised to decide precisely how much firepower their new rescue fund – to be launched mid-year – will have. A draft communiqué suggests that as of mid-2013, presuming no new bailouts have been required in the interim, the combined lending ceiling of the future ESM and existing EFSF bailout funds will be set at 700 billion euros (500 billion pledged to the ESM plus the roughly 200 billion already committed to Greek, Irish and Portuguese rescue programmes).

Up to mid-2013, if 700 billion proves to be insufficient -- i.e. someone else needs bailing out -- euro zone leaders will be able to bolster it with the 240 billion euros as yet unused in the EFSF, according to the draft, although German Finance Minister Wolfgang Schaeuble said last night that 800 billion should be the absolute limit.

Sorry, there’s more. Because the ESM will not have its full 500 billion euros capacity on day one – it will build up over time – the real available figure for the next year is more like 640 billion euros. Confused? You should be.

Nonetheless, this is probably sellable by Angela Merkel to German MPs and her public as not being a real increase at all (which is not that far from the truth) while also  probably being enough for Christine Lagarde to seek greater crisis-fighting funds for the IMF from its non-European members, most of whom have said they would provide nothing until the euro zone shows some serious intent of its own. The IMF spring meeting looms next month.

The big question is, is it enough to keep markets calm? The possibility of drawing on the extra 240 billion over the next year might do the trick but it’s not yet guaranteed that that will be agreed. If the ministers only offer up a 500 billion fund plus the money already committed to bailouts (which really is not new money at all), there could well be a wobble. The other big setpiece of the day is the Spanish budget, which Rajoy insists will be tough. Markets are watching closely. Spain reported a budget shortfall of 8.5 percent of GDP in 2011 and faces a target of 3 percent next year. It can ill-afford any slippage; its bond yields have already started rising since Prime Minister Mariano Rajoy rejected the first 2012 target agreed with the European Commission and secured a softer goal. 

Rajoy has promised a tough budget which economists predict will push Spain into a pretty deep recession this year. The government believes 35 billion euros of cuts will allow it to meet its deficit targets but given an economic downturn will cut government revenues, some analysts estimate nearly double that amount will be needed. The outside pressure for reform is unrelenting. Schaeuble said a youth unemployment rate nearing 50 percent was little surprise considering the state of Spanish labour laws.

from Global Investing:

Hungary’s plan to get some cash in the bank

Hungary says it might borrow money from global bond markets before it lands a long-awaited aid deal with the International Monetary Fund. That pretty much seems to suggest Budapest has given up hope of getting the IMF cash any time soon. Given the fund has already said it won't visit Hungary in April, that view would seem correct.

There is some logic to the plan.

Hungary desperately needs the cash -- it must  find over 4 billion euros just to repay external debt this year.

It is also an attractive time to sell debt.  Appetite for emerging market debt remains strong. Emerging bond yield premiums over U.S. Treasuries have contracted sharply this year and stand near seven-month lows. Moreover, U.S. Treasury yields may rise, potentially making debt issuance more costly in coming months.

For Hungary's government , the idea of a successful bond sale is particularly attractive as this will at a stroke  improve its bargaining position with the IMF. That's bad news, says Tim Ash, RBS head of emerging European research:

The problem is that getting cash in the bank may actually reduce the likelihood of the government actually finally cutting a deal with the IMF, so arguably increases market risk over the slightly longer term.

He concedes however:

from Breakingviews:

Euro left is powerless against austerity zealots

By Pierre Briançon

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

There may be some residual skirmishes, but the rear-guard resistance against the euro zone “fiscal compact” doesn’t stand much of a chance.

The treaty’s ratification is certainly looking problematic in some countries. Ireland will put it to a popular vote, the Dutch Labor party – whose votes the minority government needs – threatens to oppose it, and French socialist presidential contender François Hollande wants to push for a substantial “renegotiation” if he is elected. More generally, parties from the left across Europe are objecting to legislation they see as dictated by the defenders of strict fiscal orthodoxy.

Markets so far don’t seem to worry about the possible risks of the pact falling apart, and with good reason. The treaty needs the backing of only 12 of the 17 euro zone members to come into effect. If France was to be among the refuzniks, the compact would certainly lose some of its potency and much of its political meaning. But the treaty’s main requirements – enhanced fiscal monitoring, and sharper sanctions – were already fully enforceable in European law. At the urging of Germany, euro zone leaders simply agreed to enshrine those rules into a more solemn form.

The bigger problem may be that objections to ratification will be seen by the austerity zealots of the euro zone – the German government and the European Central Bank – as justification for fiscally irresponsible governments to resume their old ways. But such fears are overdone. France’s yields didn’t budge when the country was downgraded by Standard & Poor’s. But Spanish and Italian yields, still hovering around 5 percent for 10-year bonds, are a powerful reminder of the price to pay for carelessness.

In reality, it is probably time for European Union authorities to adopt a more subtle approach, considering the risks that the current recession, coupled with blind austerity, sends the region’s economy into a tailspin. The flexibility shown for Spain last week was welcome. The parties and governments who are calling for more emphasis on growth are right. But as long as the ayatollahs rule the day, they stand little chance of being heard.

from MacroScope:

Europe’s wobbly economy

Things are  looking a bit unsteady in the euro zone's economy.  Just ask Olli Rehn, the EU's top economic official, who warned this week of  "risky imbalances" in 12 of the European Union's 27 members. And that's doesn't include Greece, which is too wobbly for words. 

Rehn is looking longer term, trying to prevent the next crisis. But the here-and-now is just as wobbly. The euro zone's economy, which generates 16 percent of world output, shrunk at the end of 2011 and most economists expect the 17-nation currency area to wallow in recession this year and contract around 0.4 percent overall. Few would have been able to see it coming at the start of last year, when Europe's factories were driving a recovery from the 2008-2009 Great Recession. And it shows just how poisonous the sovereign debt saga has become.

Not everyone thinks things are so shaky.  Unicredit's chief euro zone economist, Marco Valli, is among the few who believe the euro zone will skirt a recession -- defined by two consecutive quarters of contraction -- in 2012. This year is "bound to witness a gradual but steady improvement in underlying growth momentum," Valli said, saying the fourth quarter was the low point in the euro zone business cycle.

That could still happen. Business surveys support the idea that the worst is behind us, while European Central Bank President Mario Draghi agrees that last year's collapse in confidence has now steadied, albeit at low levels. So far, the ECB has not given a strong signal on whether it will take interest rates below the 1 percent level for the first time, but the bigger risk is whether a disorderly Greek default or the threat of a severe credit freeze -- which the ECB's nearly 500 billion euros in loans has so far helped avoid --  come back to crush the green shoots of growth.

The ECB's latest lending survey showed for the last three months of 2011 reinforces the concerns of a credit crunch, as banks are still not passing the money on to the real economy. Thirty-five percent of banks reported they had tightened the standards they apply to loans to businesses, compared to only 16 percent in the third quarter. The ECB is set to make its second offer of three-year loans at the end of the month and that could ease credit risks, but may also discourage banks with bad loans on their books to reform.

So, in economist-speak, the risks are still on the downside and uncertainty remains high. Basically, things are still looking wobbly.