Market/economy disconnect?

January 30, 2013

Italy comes to the market with a five- and 10-year bond auction today and, continuing the early year theme, yields are expected to fall with demand healthy. It could raise up to 6.5 billion euros. A sale of six-month paper on Tuesday was snapped up at a yield of just 0.73 percent. Not only is the bond market unfazed by next month’s Italian elections, which could yet produce a chaotic aftermath, neither is it bothered by the scandal enveloping the world’s oldest bank, Monte dei Paschi, which is deepening by the day.

Even before this week (it also sold nearly 7 billion euros of debt on Monday), Italy had already shifted 10 percent of its annual funding needs. Clearly it, and Spain, is off to a flying start which removes a lot of potential market pressure.

But the disconnect with the miserable state of the two countries’ economies should still give pause for thought. Flash Q4 Spanish GDP figures, out later, are forecast to show its economy contracted by a further 0.6 percent in the last three months of the year, with absolutely no end to recession in sight. That looks like a good opportunity to detail the state of the Spanish economy and how it could yet push Madrid towards seeking outside help. Italian business confidence data are also due.

Banks will settle the 137 billion euros of cheap three-year European Central Bank money that they intend to pay back early, which raises another interesting angle. Some of them will avail themselves of shorter-term ECB money to compensate but there are concrete signs that the ECB’s balance sheet is shrinking on a trend basis. That amounts to a slight policy tightening at a time when other central banks around the world are printing money furiously, or at least not reversing course. Talk of a currency war may be overdone but in that environment, upward pressure on the euro could well persist – not good news for a currency bloc back in recession. The double whammy is that there is little sign that banks are prepared to increase their lending.

If markets are to turn tail, the catalysts are more likely to come from the United States courtesy of a Federal Reserve policy meeting, December jobless figures and Q4 GDP this week. But the macro news has been fairly consistently good from the States in recent weeks and the Fed, with its lower unemployment target, is unlikely to even hint at an end to ultra-loose policy yet. So it really comes down to how far ahead of reality markets have got. World stocks are up the best part of four percent since the turn of the year.

Policymakers’ dilemma about regulating banks in a way that could prevent future financial crises, while not choking off much-needed bank lending in the  process, is laid bare again by European commission Michel Barnier, who told the FT that implementation of an EU report on the structure of European banks must not penalize lenders who are supporting the economy. Sounds like there could be another backtrack is in the works following signs that the apparently concrete commitment that the euro zone rescue fund could recapitalize banks directly from 2014 – thereby relieving heavily indebted governments of that burden – is being loaded with caveats.


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