A week to reckon with

June 14, 2013

The week kicks off with a G8 leaders’ summit in Northern Ireland. Syria will dominate the gathering and the British agenda on tax avoidance is likely to be long on rhetoric, short on specifics. But for the markets, this meeting could still yield some big news. For a start, Japanese prime minister Abe is there – the man who has launched one of the most aggressive stimulus drives in history yet has already seen the yen climb back to the level it held before he started. Abe will also speak in London and Warsaw during the week.

The financial backdrop could hardly be more volatile with emerging markets selling off dramatically since the Federal Reserve warned the pace of its dollar creation could be slowed. Berlin has said the G8 leaders are likely to discuss the role of central banks and monetary policy, and Angela Merkel will hold bilateral talks with Abe during the summit. President Barack Obama travels to Berlin after the summit for talks with Merkel.

The central banks of Turkey, Switzerland and Norway all have monetary policy decisions to make in the coming week and may have some interesting things to say about the revival of market turmoil after months of calm. The Norwegians have said interest rates are likely to stay at 1.5 percent for months to come and the Swiss National Bank is unlikely to loosen its cap on the Swiss franc which has served it so well, particularly given markets are now back in flux and traders are starting to talk about flight-to-safety moves again. The elephant in the room is the Federal Reserve’s latest policy decision on Wednesday, followed by a Ben Bernanke press conference.

The Turks are the hottest story of the moment on our patch with Prime Minister Tayyip Erdogan first saying his patience had run out after almost two weeks of anti-government protests, and then sounding more conciliatory, holding talks with protest leaders. How this ends will go a long way to dictating the investor view of Turkey and how its markets recover (if at all) from a drubbing inspired by a perfect storm of domestic and international factors – about $8 billion had fled Turkish markets from the beginning of May to last Wednesday and a gaping current account deficit doesn’t help.
The central bank has already come in to defend the lira and while it said it saw no need to raise the upper band of its interest rate corridor who knows what the next few days will bring. At its May meeting, it cut all its key rates by 50 basis points, but with the lira under huge pressure you can rule out a repeat of that. Indonesia was first out of the blocks in recent days, becoming the first central bank in Asia to raise rates since 2011. It’s early days but a repeat of the capital outflows that marked the Asian financial crisis of the late 1990s is an unpleasant reminder of the damage that can be wrought.

The euro zone bears watching as always, now we’re back into turbulent times.

Spain, France and Germany all hold bond auctions during the week with the benevolent bond market conditions of the first five months of the year now gone. Italian and Spanish borrowing costs fell for 10 months after European Central Bank chief Mario Draghi pledged to do whatever it takes to save the euro but have begun creeping up since Bernanke’s intervention. Both countries have frontloaded their funding for this year, so some of the pressure is off. Germany could start to benefit from safe haven status again so maybe France is the most interesting. Its economy is flatlining, the government is railing against exhortations from Berlin and Brussels to raise the pace of structural reform and yet it can still borrow for 10 years at not much more than two percent.

If the market volatility prompted by the Fed’s intervention, which has caused a more modest rise in peripheral euro zone borrowing costs than the carnage seen in emerging markets, does not calm soon investors may well start looking askance at the currency bloc’s high debtors again. Things will have to get much worse than they are now but Greek coalition parties are at each other’s throats, the IMF has just proclaimed that Portugal’s public debt position remains very fragile and Italy has declared it will make no more cuts although its deeper-than-expected recession is pushing its deficit up.

Not for the first time, Greece is the most dangerous potential flashpoint. With its stock market downgraded to emerging status by equity index provider MSCI, Prime Minister Antonis Samaras faces a potentially serious revolt within his coalition government over the abrupt shuttering of the state TV broadcaster. Samaras is seeking to resolve the row but the coalition is the guarantor of Greece’s second bailout and if it fell, the country would be thrown back into crisis (and that’s aside from its relentless recession, 27 percent unemployment rate and faltering privatization drive, all of which point to a further debt restructuring in the future).

Spain also remains deep in recession with staggering rates of unemployment. The International Monetary Fund will publish its latest review of the Spanish economy on Tuesday. Slovenia has avoided a bailout so far. Its parliament is expected to approve the government’s plan to sell 15 state companies on Thursday or Friday. Flash PMI surveys for the euro zone, Germany and France will give the latest snapshot of the region’s economic malaise.

All that makes it doubly important that EU leaders make real progress on agreeing the structures of a cross-border banking union, including measures to restructure or wind up failing banks. A meeting of euro zone finance ministers on Thursday will pave the way for the following week’s EU summit. There are signs that some of Germany’s EU counterparts are prepared to challenge its reluctance to include a cross-border bank resolution scheme in a banking union. Without a mechanism to wind-up or restructure failing banks, with pooled risk, the euro zone crisis cannot be declared over and the seeds of a future blow-up will have been sown. Berlin is not expected to budge before German elections in September. The big question is whether it will do thereafter.

In Britain, the Mansion House speeches delivered by finance minister and central bank chief are a fixture in the economic calendar. This time, it will be a further opportunity for Bank of England Governor Mervyn King to speak bluntly before handing the reins to Mark Carney next month. George Osborne is expected to announce the sale of the government’s 39 percent stake in Lloyds bank. A similar move for state-owned RBS will come later.


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