Euro zone looks to Washington
So the debt crisis is back (did it ever really go away?) but it’s not yet anything like as acute as it was late last year.
Spain is coming under real market pressure, and dragging Italy with it to an extent, but there are good reasons to think it won’t fall over; banks well funded for now and the government’s savvy move to take advantage of benign early year conditions to shift almost half its 2012 debt issuance in three months.
Madrid faces another key test with a Thursday bond auction. Two weeks ago, it suffered its first wobbly debt sale for some months. The turning point is pretty clear – Prime Minister Mariano Rajoy’s decision to rip up Spain’s agreed deficit target for 2012 without consulting his partners. Since then, Spanish borrowing costs have soared though given the amount of debt Madrid has already shifted, that might not be as damaging as it was.
Aside from the auction, Rajoy is holding talks with his powerful regional leaders about where the axe should fall on health and education spending. The consensus so far is that having bitten this bullet, he is deadly serious about cutting debt and reforming the economy. Any backsliding in the face of regional recalcitrance could be taken very badly by the markets.
Aside from Spain, everything builds to the big IMF meeting in Washington at the back end of the week, which hopes to make some headway on boosting the Fund’s crisis-fighting resources.
IMF chief Christine Lagarde said more crisis-fighting funds were needed, though maybe not as much as had been thought as risks were receding (the Spanish will be heartened and maybe surprised to hear that!). But the deal may not be done in Washington and she emphasized that IMF resources would be devoted to protecting non-euro zone countries caught up in the turmoil. That may be the political message she needs to deliver to make headway.
There is some doubt surrounding the IMF fund-raising drive. Germany (and China) refuses to heed calls from Washington and elsewhere to play a part in rebalancing the world economy by consuming more. For the euro zone, such a move would give Germany’s debt-ridden partners half a chance of recovering while they stick to the austerity drive. Without it, ever deeper recessions are likely.
Furthermore, the euro zone deal two weeks ago on its new rescue fund was spun as more than it was. Finance ministers claimed an 800 billion euros firewall had been erected. In reality, it was really only 500 billion. It’s not that the latter is an insignificant sum, it was the cack-handed attempt to overplay it that is likely to have gone down badly with non-European contributors to the IMF.
Given all that, why should they agree to bolster the Fund? The answer, in the end, is likely to be that the possible consequences of doing nothing remain too ghastly to contemplate, so a deal will be done.
The first round of French presidential elections are unlikely to move markets unless one of the two frontrunners is stunningly knocked out. Round two, assuming it is President Sarkozy versus Socialist challenger Francois Hollande, should be a very different matter given the latter is intent on rewriting the bloc’s new fiscal rules.
One of the corollaries of the new euro zone flare up is that money is again flowing into the Swiss franc to the point where the Swiss National Bank’s cap was temporarily breached. Given that, the SNB desperately needs a new full-time boss. The caretaker, Thomas Jordan, is likely to be anointed during the week.
On the macro front, Germany boasts both its ZEW and Ifo sentiment indicators during the week, which will give strong indications as to its ability to avoid the recession set to engulf the wider euro zone.