MacroScope

Euro zone week ahead

By Mike Peacock
May 20, 2013

It looks like a week short of blockbusters, particularly today with much of Europe on holiday. But there will be plenty to chew over over the next few days on the state of the euro zone and whether newly-printed central bank money lapping round the world risks throwing things off kilter.

Flash PMIs for the euro zone, Germany and France for May, plus the German Ifo index, follow first quarter GDP data which showed Europe’s largest economy just about eked out some growth but nobody else in the currency bloc did. That trend is likely to be reaffirmed with the harsh winter, having curbed German activity in Q1, allowing for a rebound in sectors like construction in Q2. France and the rest of the pack are unlikely to be so lucky.

For the markets, this leaves all sorts of assets in demand since if the economy worsens, central bank largesse will stay in place for longer and could be enhanced and if recovery finally shows up, well then that’s good for stock markets at least. The only real losers so far have been in the commodities and energy arena. The 500-pound gorilla in the room is how the world economy will cope when the big central banks finally halt and even start to reverse their extraordinary stimulus policies but that looks like a question for 2014 at the earliest. Interestingly, both the IMF and Bank for International Settlements issued warnings about this on the same day.

Ten months after his pledge to save the euro fundamentally changed the dynamics of the currency bloc’s debt crisis, European Central Bank chief Mario Draghi returns to the scene of the crime (I know, that’s the wrong word for all but the hardest hardliners) – London – to deliver a keynote speech. Draghi has said the ECB is prepared to act further if the economy worsens, having already cut interest rates to a fresh record low this month. But what?

Its bond-buying plans are dormant because no country needs the help at the moment and there is no talk of a repeat of last year’s 1 trillion euro splurge of cheap long-term liquidity to banks. There is talk of cutting the deposit rate – the rate banks get for parking funds at the ECB – into negative territory to try and get them to lend. But will that do much? Despite being in a world awash with central bank money and stock markets in the ascendant, the fact that safe haven bond markets such as Bunds and U.S. Treasuries haven’t sold off much denotes ongoing nervousness among banks and investors. And why would banks lend to pesky, problematic companies when there seem to be bumper returns to be had in the markets?

Bank of England Mervyn King is also out and about as are, further afield, the Federal Reserve and Bank of Japan chiefs. Pretty much a full central bank house with questions starting to circulate about when the Fed may pull the plug on its money printing and whether Tokyo thinks the yen has fallen far enough.

German officials have been getting active in recent weeks in some potentially interesting ways. Finance Minister Wolfgang Schaeuble and labour minister Ursula von der Leyen will talk up a “New Deal for Europe”, a Franco-German initiative to tackle youth unemployment which will be aired in full the following week. And the Bank of France is hosting a two-day conference with the Bundesbank, with their respective chiefs – Noyer and Weidmann – running the show.

Together with recent German initiatives such as tentatively offering Spain money and help to get credit flowing to smaller companies, Berlin seems to be embarking on a number of bilateral initiatives which circumvent Brussels. Is something going on here? The working assumption has been that all bets are off until September elections are out of the way.

Bond market pressure on the euro zone remains entirely absent with the ECB underwriting now augmented by the new Japanese money coursing around the world seeking a decent return. Spain will sell short-term treasury bills and hold a full bond auction in the week to come. It is a good example of the market/economy disconnect. It is mired in recession but has already effortlessly shifted more than half the bonds it needs to this year in less than five months. Italy has shifted 65 percent of its 2013 debt issuance needs already and Spain has done more than half with investors lapping up each and every auction and syndication.

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