A curate’s egg — good in parts

April 23, 2012

An action-packed weekend with both good and bad news for the euro zone, which may — net — leave its prospects little clearer.

Item 1: The IMF came up with $430 billion in new firepower to contain the euro zone-led world economic crisis, although some of the money will only be delivered by the BRICS once they have more sway at the Fund. Nonetheless, the figure at least matches expectations and could give markets pause for thought. The official line is that it is for non-euro countries caught up in the maelstrom but no one really believes that. If a Spain is teetering, IMF funds will be there. Together with the 500 billion euros rescue fund set up by the euro zone, there is still barely enough to ringfence both Italy and Spain if it came to it. But will it come to it?

Item 2: Socialist Francois Hollande came out top in the first round of the French presidential election and is now a warm favourite to win. Some fear that could weaken the Franco-German motor which must be humming smoothly if further crisis-fighting measures are to be convincing. Others say he is essentially a centrist who, either way, will be constrained by the realities of the euro zone situation. Domestically, his focus on tax rises over spending cuts and a slower timetable for cuts could drive up French borrowing costs. Attempts by Hollande and President Nicola Sarkozy to woo the substantial votes that went to the far right and far left could lead to some nerve-jangling campaigning messages for the markets to swallow in the run-up to the May 6 second round.

Item 3: The left-field event of the weekend was the collapse of the Dutch government over budget plans. The hawkish Dutch could now delay ratifying the EU’s new fiscal pact. Finance minister De Jager, a hardliner, promises to try and cobble together enough support in parliament for a tough budget but there is absolutely no certainty he will succeed. The standoff raises the prospect of a rating cut and an even smaller band of top-rated euro zone members. Early elections, and a period of limbo, are quite likely – a negative for the euro zone which could well balance out the progress made at the IMF. And polls suggest popular support for austerity is waning in even this “core” euro zone member.

The euro is on the back foot, getting limited support from the IMF deal, with looming Italian and Dutch debt auctions casting a long shadow. Safe haven German Bund futures are up at the open, French bond futures are down, which tells you something. Dutch debt will doubtless come under pressure. The main focus remains on Spain and Italy with the latter trying to sell a variety of debt through the week against an unfavourable backdrop.
Concerns about Spain in particular are well justified but it is not yet close to the precipice. The banks are at the heart of the country’s problems and are carrying the biggest burden of bad loans since 1994. They will almost certainly need more capital at some point. On the other hand, the central bank points out that thanks to the ECB’s three-year money offer the banks have loaded up on cash to the extent that their funding needs are covered for this year, and maybe next too. Add to that the fact that Spain has shifted half its government debt issuance for 2012 in the first third of the year and it is clear it has some time to turn around market sentiment, which soured sharply when Madrid reneged on an agreed deficit target back in March.

The European Central Bank remains the key player. Weekly bond-buying data  later on Monday are likely to show it remained inactive last week but with Spanish 10-year yields back above six percent, it’s a live issue again. Given the stiff opposition from Bundesbank chief Weidmann and others, who are actually pushing for an exit strategy from extraordinary measures, it is likely that things would have to get a helluva lot worse before the ECB would return to the fray.

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