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from MacroScope:

All eyes on Wednesday EU summit

After last week’s hefty losses, European stock gained yesterday and are up up again this morning, denoting some optimism about the Wednesday supper summit of EU leaders, which might well be unrealistic.

The European growth measures that we know are in the works – boosting the paid-in capital of the European Investment Bank and plans for 'project bonds' underwritten by the EU budget to finance infrastructure – might help a little but will fall a long way short of turning the euro zone economy around, so unless we get something more, on either the growth or the building defences fronts, there’s scope for investor disappointment.

Europe’s international partners continue to demand more dramatic crisis action. After the G8 summit, President Obama was out last night with four demands: - firewalls to protect countries from Greek contagion (are the ESM and IMF funds now viewed as insufficient?), - recapitalization of banks that need it (Spain to the fore here presumably), - A growth strategy to run alongside tight fiscal measures (easier said than done), - easy monetary policy to help the likes of Italy and Spain keep cutting debt (the ECB thinks its 1 percent rate is very loose and is unlikely to cut soon with inflation above target and will only flood the system with more liquidity in utter extremis)

Nothing new there but it keeps up the drumbeat of pressure ahead of the EU get-together. We know French President Francois Hollande, with the backing of others, will press the case for common euro zone bonds at the summit and also know that German opposition will not weaken one jot on that score. Spain’s Rajoy is pressing for more ECB involvement, presumably by reviving its bond-buying programme. Given internal opposition to that within the ECB that is probably the least likely measure to be reactivated, yet anyway.

Despite money flowing out of Greek banks, and at least the threat of it spreading more widely if Greece bombed out of the euro zone, there is no hint yet of any planning for any scheme to underwrite bank deposits across the bloc, probably because the ECB and Germany will not countenance underwriting it. The golden rule of this crisis is that red lines have and will be crossed when it reaches breaking point. We’re not there yet.

With so much focus on Greece and Spain, Portugal has been somewhat overlooked in recent weeks but it will quite likely need a second bailout at some stage and if Greece prompts a wave of contagion, it will be firmly and instantly in the firing line.

from MacroScope:

Risk of contagion if Greece exits euro: WestLB

What happens if Greece leaves the euro? No one can say for sure. But John Davies at WestLB, finds it difficult to envision a benign outcome.

Greece’s economy, at around $300 billion, is very small compared to the euro zone as a whole. The problem is if other countries follow suit – or are pressured in that direction by stubborn financial markets.

Such a scenario doesn't bear thinking about because it is so horrible.

There is a good chance that the market would immediately trade Portugal towards pre-debt swap Greece levels. The next in line would certainly be Ireland and Spain.

Initially you have got to assume that spreads would become even more dislocated. As you are moving out and down the credit curve the ones with the weakest credit ratings will likely suffer worst, at least initially, because we are moving clearly into the world of the unknown and that's precisely what the market doesn't like.

The Greek elections have left a political vacuum that is raising speculation that the country may eventually exit the euro. Last Sunday, Greek voters punished mainstream parties that supported harsh austerity in exchange for international bailout cash. That left the Greek parliament with a jumble of minority parties that have been unable to form a government.

The leaders of Greece's once-dominant conservative and socialist parties made a push on Friday to avert new elections and prevent a victory by a radical leftist who has promised to tear up its international bailout deal.

Inability to implement the reforms set out by international lenders amid this political void could compromise the country's life-support bailout money and lead to a default. This could make the country's membership of the euro increasingly unsustainable, even though those very reforms risked choking growth further in an economy suffering its fifth year of recession.

Even Germany, the key driver of growth in the euro zone, might eventually be threatened by worsening financial and economic conditions around it. And what of the bullish German Bund market which seems to know no bounds? Davies again:

from Global Investing:

Three snapshots for Tuesday

Equities in the countries most exposed to the euro zone crisis seem to be being hit especially hard this year. The Datastream index of shares in Portugal, Italy, Ireland, Greece and Spain has a total return of -5.3% this year compared to +8.9% for a euro zone index excluding those countries.

U.S. consumers went back to using their credit cards in March to keep spending while student and new-car loans shot up as the value of outstanding consumer credit jumped at the fastest rate since late 2001, data from the Federal Reserve showed on Monday.

Total consumer credit grew by $21.36 billion - more than twice the $9.8 billion rise that Wall Street economists surveyed by Reuters had forecast.

Perhaps some of that credit card spending is finding its way to luxury goods companies - there certainly don't seem to be too many worries about an economic slowdown coming through in their share price performance:

from Global Investing:

Three snapshots for Thursday

The European Central Bank kept interest rates on hold on Thursday.  President Mario Draghi urged euro zone governments to agree a growth strategy to go hand in hand with fiscal discipline, but as thousands of Spaniards protested in the streets he gave no sign the bank would do more to address people's fears about the economy

The divergence between Euro zone countries is starting to impact analyst estimates for earnings. As this chart shows earnings forecasts for Spain and Portugal are seeing more downgrades than Germany or France.

The inflation rate in Turkey rose to 11.1% in April, putting pressure on the central bank to raise interest rates:

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:

Hair of the dog? Citi says more LTROs in store

Just as global markets nurse a hangover from their Q1 binge on cheap ECB lending -- a circa 1 trillion euro flood of 1%, 3-year loans to euro zone banks in December and February (anodynely dubbed a Long-Term Refinancing Operation) -- there's every chance they may get, or at least need, a proverbial hair of the dog.

At least that's what Citi chief economist Willem Buiter and team think despite regular insistence from ECB top brass that the recent two-legged LTRO was likely a one off.

Even though Citi late Wednesday nudged up its world growth forecast for a third month running, in keeping with Tuesday's IMF's upgrade , it remains significantly more bearish on headline numbers and sees PPP-weighted global growth this  year and next at 3.1% and 3.5% compared with the Fund's call of 3.5% and 4.1%.

But its euro zone calls are gloomiest of all. First off, it sees two consecutive years of economic contraction of the bloc as a whole -- a 1.0% shrinkage this year followed by 0.2% drop in 2013. Against this dire backdrop, it expects  Spain to be forced to seek Troika (EU, IMF and ECB) support later this year that will be focussed on recapitalizing and restructuring its ailing banks and it also expects both Portugal and Ireland to need second bailouts from the same source.

And with that sort of pressure from deleveraging, austerity, sovereign debt stress and recession , the ECB will have to bring out yet another punchbowl, it reckons.

We expect that renewed EMU strains will prompt the ECB to launch at least one more multi-year LTRO and continue to pencil in one or two more rate cuts by end-2013.

Yet, just like the euphoric effects of both the binge and "morning after" drink, the problem with LTRO is that it risks causing more problems than it solves by tying the banks of weak peripheral euro states ever closer to their ailing sovereigns.

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 Global Investing:

Bullish Barclays says to buy Portuguese debt

Some bets are not for the faint-hearted. Risky punts are even less so following a sovereign debt crisis, one that has riddled European debt markets for two years. Barclays Capital, however, recommends a particularly unusual bet, one that your parents might baulk at.

It will be of little surprise that Barcap is bullish on the year, advising towards assets that will perform well in an environment of US-led global growth, easy monetary policy and tight oil supplies following reduced tail-risks in Europe curbed by cheap money from the European Central Bank.

Now that the rush of the addictive LTRO money is over and the dust is settling on central banks’ balance sheets, Barcap is brave enough to recommend an unlikely candidate and one of the recent targets of financial markets -- Portugal.

Laurent Fransolet, Managing Director of Research at Barclays Capital told reporters at a Global Outlook briefing today:

“One of the top trades that we recommend in the global outlook is to be long on Portugal, which is a little bit of a roll of the dice. It is a fairly high risk, high return strategy. The sustainability of the debt, the fiscal consolidation, the long-term economic performance – these are still questions that remain on people’s minds for the foreseeable future.”

But the investment bank said it took the EU and the IMF at their word on implications following the Greek Private Sector Involvement (PSI) bailout deal.

“After the Greek PSI, we do believe the statement that Greece is unique and that anything will be done for Portugal for as long as needed if Portugal does deliver its side of the bargain -- which has been the message by the European officials and by the IMF. In the very near term you probably have some opportunity for Portugal to outperform from what are fairly cheap levels.”

from MacroScope:

The euro zone today – strikes, reform and recession

The euro zone economy looks to have contracted at a faster pace in March, according to the latest purchasing managers' data, hours after ECB President Mario Draghi declared the worst of the debt crisis to be over. A mild recession appears to be in prospect with the probable exception of Germany.

The two aren't mutually exclusive. Even if the existential threat to the currency bloc has passed, many of its members face years of economic hardship yet. With China's equivalent report also coming in weak, the short-term signs are not auspicous.

Italy’s largest trade union has called a strike for the near future over Prime Minister Mario Monti’s labour reforms which have been rehardened to make it easier to fire not just workers in new jobs but right across the labour force. The prime minister says he won’t negotiate further given he has the support of other unions as well as employers groups. However, there is room for “fine tuning” today and tomorrow. The CGIL union has called for an eight-hour general strike with more to follow.

This is big stuff. A number of key factors have helped move the euro zone debt crisis on from critical to chronic; top of the list was the ECB’s creation of a trillion euros of three-year money but not far behind came the elevation of Monti and the hope invested in him that he can turn the Italian economy around. If the euro zone’s third largest economy fell over, the currency bloc really would be on the skids.

Monti must convince markets – which continue to give him the benefit of the doubt for now - that he can raise Italy’s trend growth rate if its 120 percent of GDP debt pile is ever to be eaten into. If faith in the technocrat premier wanes, it could have a significant effect on currently benign investor sentiment towards the euro zone.

Today, bailed out Portugal also faces a general strike protesting at austerity measures which the government is doing its best to stick to, without much prospect that it will turn the economy around. Data on Wednesday, showed Portugal's core public deficit nearly tripled in the first two months of 2012, showing a deepening economic slump is denting tax collection and stoking concerns it will  follow Greece in requiring more rescue funds. The difference is there is much greater euro zone goodwill towards Lisbon, so those funds will be provided without much grumbling.

Ireland, the country that seems to have a chance of riding the austerity wave successfully, produces Q4 GDP data which will show whether the government met its 1 percent growth target next year, while Germany continues to look like an economy on a different planet to its currency peers. It expects to balance its budget for the first time in more than 40 years in 2016 thanks to strong growth and full tax coffers.

from MacroScope:

Today in the euro zone

Morning all from a fogbound London. Visibility may be down to a minimum but there is a developing view that the euro zone debt crisis, if not solved, is in remission.

Spain should follow Italy’s lead yesterday and sell short- to medium-term bonds with ease despite a tussle with the EU over what deficit level it should be aiming for next year. Madrid will sell up to 3.5 billion euros of three- and four-year paper, a lower amount than it has been pushing out so far this year, which means it should be snapped up.

There has been some disquiet in the market after Prime Minister Mariano Rajoy threw out a Brussels-agreed target of a 4.4 percent/GDP deficit this year and said he would only shoot for 5.8. His peers have subsequently hauled him back to 5.3. But any doubts over debt slippage continue to be overwhelmed by the wall of money created by the ECB which is sloshing around the financial system looking for a home.

If Spain sells at the top end of its target range today, it will have shifted nearly 45 percent of its annual issuance in less than a third of the year. Italy is also making great strides (it shifted six billion euros of debt yesterday at markedly lower yield) – a factor that is taking further stress out of the euro zone debt crisis, at least in the short-term.

Rewind to the beginning of the year and everybody was fretting about Italy facing a mountain of refinancing (with the same true of Spain to a lesser extent) and now it looks like no more than a small bump in the road thanks to the ECB’s largesse.

Markets remain (dread phrase) “risk on” mode. German Bund futures have shed another half point although European stocks look flatter after a good run so far this week. France also comes to the market with a bond sale today and should benefit from the same prevailing market conditions.

After the Greek parliament formally approved the terms attached to a second bailout on Wednesday, Portugal has been firmly identified as the next shoe to drop although the EU's economy chief, Olli Rehn, said late yesterday that Lisbon was on track with its bailout programme. While Italian and Spanish borrowing costs have tumbled, largely thanks to the ECB, Portugal has failed to hitch on to that ride. However, a second package for Lisbon would probably need to be in the region of 30 billion euros, not a sum to stretch the euro zone’s resources.