MacroScope

What now?

 

The slow motion Cypriot car crash of the past five days reached impact point last night when not a single lawmaker voted for the bailout with bank levy attached – the first time a euro zone legislature has simply said no.

So what next? The finance minister is in Russia, ostensibly to seek an extension on an existing 2.5 billion euros loan on better terms, but could there be more on offer besides? The Eurogroup made clear last night that the 10 billion euros bailout was still on the table but that Nicosia had to come up with 5.8 billion euros of its own – the sum that a levy on bank depositors was supposed to raise. Could Moscow fill that gap, maybe in return for a slice of the island’s untapped offshore gas reserves? It looks unlikely but not impossible and there are powerful geopolitics at play. That there will be no more money from the euro zone looks like a given and there seems to be a resolve that it would be better to let Cyprus default then buckle at the last moment.

Finance minister Sarris has just said he hopes for a deal on the existing Russian loan today. In Nicosia, the president is meeting party leaders.

The most sensible solution would be to spare Cypriot depositors with less than 100,000 euros – who were supposed to be protected anyway – and hit the big boys. That would go some way to negating the fear of a bank run elsewhere by belatedly respecting the deposit guarantee. Nicosia has rejected that up to now, fearing the destruction of its banking model but at eight times the size of the economy, that’s no sort of model anyway. What is crystal clear is that Germany will not accept another bailout foisted wholely on euro zone taxpayers, nor would the Bundestag ratify it.

The euro zone has some leverage. Cyprus’s main two banks are basically only standing because of the European Central Bank, which said last night that it would continue to provide liquidity “within the rules” i.e. to banks which are solvent. That means money flows for now but the bulk of the bailout will go to sort out the banks so if it completely falls apart they could not be viewed as solvent.

Cypriot crunch point

Cypriot lawmakers are supposed to vote today on a bailout that hits at least some of its bank depositors but the president’s spokesman has said any such legislation is unlikely to pass. This could be brinkmanship but it doesn’t sound like it.

Last night, euro zone finance ministers urged Nicosia to spare depositors with less than 100,000 euros in the bank and hit the richer harder, in order to raise 5.8 billion euros to free up a 10 billion euros bailout. Without it, Cyprus will surely go bankrupt but that is a deal that President Anastasiades baulked at in Brussels over the weekend. The government faces a stark choice: hit those who vote for it and rip up the deposit insurance they thought they had, or clobber the richer (many of them Russians), thus threatening the meltdown of its banking model.

Despite their belated support for the little guy, the euro zone will accept pretty much anything that raises the requisite cash. Germany and others insist the days of bailouts funded solely by taxpayers are over and the Bundestag probably wouldn’t sanction any other sort of deal.

A Rubicon crossed

What a weekend. The euro zone crossed a dangerous Rubicon by whacking Cypriot bank depositors as part of a bailout – a dramatic departure from previous aid programmes. The finance ministers insist it is a one-off (as they did for Greece) but if investors and bank customers fear a precedent has been set, there could yet be a serious backwash for the euro zone. And all this for six billion euros? It seems perplexing to say the least although our trawl of the streets of the euro zone periphery has detected little alarm so far.

Markets are voting with their feet. The euro has dropped well over one percent, European stock futures are pointing to losses of two to three percent and the safe haven Bund future has leapt a full point at the open. Italian bond futures have done the reverse, suggesting that in the bond market at least, there is more than a little concern about contagion from Cyprus. “The crisis is back,” one bond trader told us. “Precedent” is the word on everybody’s lips. I’ve used it before but Bank of England Governor Mervyn King produced the definitive line on bank runs – it’s never logical to start one but it sure could be logical to join one.

To muddy the waters further, the Cypriots are trying to renegotiate the deal to ease the 6.5 percent burden on smaller depositors and raise it on the richer (from 9.9 percent). This suggests that the president fears that today’s parliamentary vote may be lost without changes. If it is lost – no party has a majority and three of them said yesterday they wouldn’t support the programme – we’re in for a real rollercoaster as everyone scrambles to avoid a default, with all the reputational damage that will do to the euro zone. At that point, we could probably kiss goodbye to the five months of calm imposed by the European Central Bank and its “do whatever it takes” pledge.

Euro bailouts — one out, one in

We had thought the end-of-week EU summit was going to be a lacklustre affair but things are starting to bubble up.

Ireland announced last night it would issue its first new 10-year bond since it was bailed out in 2010. It sounds like the books on the syndicated issue will open today with dealers predicting strong demand. This is a crucial step in Dublin becoming the success story the euro zone desperately craves. Some European Central Bank policymakers have said the bank’s bond-buying programme could be deployed to help Ireland once it has demonstrated its ability to issue debt in a variety of maturities. Others, notably Bundesbank chief Jens Weidmann, appear less keen on the idea.

With yields below four percent (they peaked above 15 percent in 2011) and needing to raise only a few billion in debt this year, it’s not clear that Ireland even needs ECB help to put the bailout behind it, but bond-buying support would certainly seal its exit and also show the ECB’s intent to markets. Further down the line, it will be worth pondering whether Ireland’s journey demonstrates that austerity was the right medicine. Plenty of euro zone policymakers will say so. The interesting question to address would be whether Dublin could have got there faster with more leeway to boost growth and therefore tax revenues.

Euro zone week ahead

Italy will continue to cast a long shadow and has clearly opened a chink in the euro zone’s armour. It looks like the best investors can expect is populist Beppe Grillo supporting some measures put forward by a minority, centre-left government but refusing any sort of formal alliance. That sounds like a recipe for the sort of instability that could have investors running a mile. The markets’ best case was for outgoing technocrat prime minister Monti to support the centre-left in coalition, thereby guaranteeing continuation of economic reforms. But he just didn’t get enough votes. Fresh elections are probably the nightmare scenario given the unpredictability of what could result.

The story of the last five months has been the bond-buying safety net cast by the European Central Bank which took the sting out of the currency bloc’s debt crisis. But now it has an Achilles’ Heel. The ECB has stated it will only buy the bonds of a country on certain policy conditions. An unwilling or unstable Italian government may be unable to meet those conditions so in theory the ECB should stand back. But what if the euro zone’s third biggest economy comes under serious market attack? Without ECB support the whole bloc would be thrown back into crisis and yet if it does intervene, some ECB policymakers and German lawmakers will throw their hands up in horror, potentially calling the whole programme in to question.

In other words, until or unless a durable government is formed in Italy which can credibly say and do the right things, the euro zone crisis is back although not yet in the way it was a year ago when break-up looked possible.

Italy gives new bite to euro zone crisis

Don’t start putting out the tinsel yet. Just when we thought we had a smooth glide path into Christmas the euro zone has bitten back.

Over the weekend, Italy’s Mario Monti called Silvio Berlusconi’s bluff and said he was pulling the government down which will mean early elections in February. The budget bill will be passed and then the country will be in a potentially precarious state of limbo as parliament is dissolved. Italian bond futures have opened more than a point lower, which denotes a reasonable measure of alarm, although the safe haven Bund future has only edged up so we’re far from panic mode.

The big question is whether a government results that will stick to Monti’s agenda and whether he himself will have a prominent role to play in the administration. There are constitutional difficulties to keeping Monti as prime minister since he has said he would not stand at the election, though he has also said he would be prepared to step in again if no stable government is formed. Most likely, presuming a government is elected that supports his reforms, is that he will play a key role but not take the top job.

Calm after the storm

After months of bickering and struggle, the euro zone and IMF have agreed on a scheme which will notionally cut Greece’s mountainous debt to a level they view as sustainable in the long-term. Athens has now launched a buyback of its debt at a sharp discount from private creditors which should wipe 20 billion euros of its debt pile – a key plank of the plan.

Is the problem solved? Absolutely not. But has Germany achieved its goal of delaying any disasters, or really tough decisions, until after its elections in the Autumn of 2013? Almost certainly. So we could (famous last words) be in for a period of relative calm on the euro zone crisis front.

German Chancellor Angela Merkel and her finance minister have begun quietly hinting that euro zone government and the European Central Bank may eventually have to take a writedown on the Greek bonds they hold to make Athens’ debt controllable. That won’t happen for at least two years but in the meantime, bailout money will flow and Greece will survive.

If Greek talks are tough, check out the EU budget

The EU budget summit, which could turn into a marathon as it tries to nail down monies for the next seven years, begins today. With the euro zone repeatedly failing to nail down a Greek deal, the EU would be well advised not to let this negotiation fall apart too. Having said that, there is little sign of great concern in market pricing – presumably the ECB’s pledge to buy government bonds in whatever amount it takes to steady the bloc continues to suppress investor nerves and short sellers.

Net contributors to the budget including Germany, France and Britain want to cut 100 billion euros from the European Commission’s draft budget proposal, but differ over which areas to cut. Meanwhile, the main beneficiaries of EU funding such as Poland, Hungary and the Czech Republic oppose cuts. The meeting is intended to lay the groundwork for political agreement on the budget by EU leaders at their final summit of 2012 in December. It will last two days, maybe more and it could well be that no agreement is reached. Officials say only a cut in real terms – for the first time ever – is likely to do the trick.

Back to Greece and prime minister Samaras will meet Eurogroup chief Juncker in Brussels although he is now largely a passive, angry bystander in this process. While Juncker’s assertion in the early hours of Wednesday morning that a deal was only held up by complex technical matters has some truth to it, there is a far deeper split to be closed.

French downgrade to give way to Greek debt deal

Big event overnight was the downgrading of France to Aa1 by Moody’s, bringing it in line with Standard & Poor’s which cut back in January. There are some funds (even in this age of AAA scarcity) which will only invest in top notch debt and take their cue to exit once two agencies have dropped that rating, but the immediate impact is unlikely to be dramatic. The euro has slipped on the news, French government bond futures have dropped about a quarter of a point and safe haven German Bund futures have edged up. “Although it’s not great, the market doesn’t seem too worried,” one trader said.

However, it does throw a spotlight on the gap between France’s economic health (lack of it) and the record low costs it can borrow at. We’ve written plenty of good stuff on this already and French finance minister Moscovici gave his response to us last night. Interestingly, it wasn’t an attack on the ratings agencies, which we’ve seen before from Europe in these circumstances. Instead, he said it was an alarm bell telling the government to pursue structural reforms and reaffirmed his commitment to meet budget deficit targets. He noted that France continued to enjoy record low yields after S&P cut early in the year. The only thing he really took issue with was Moody’s view of the large risks to France’s banks. It warned it could cut France’s rating further.

As the day progresses, thoughts will turn to Greece and this evening’s meeting of euro zone finance ministers. We’ve had a strong exclusive readout of what is likely – an endorsement in principle to unfreeze loans to Greece but a final go-ahead for December disbursement only after a few final reforms are enacted in Athens. Berlin has suggested bundling together the next few Greek bailout tranches in order to pay over 44 billion euros if a green light is given. Others want only the next tranche of 31 billion to be handed over at this stage. Either way, that will keep the show on the road but there is plenty more to be decided yet.

Greek debt — a riddle, wrapped in a mystery, inside an enigma

So said Winston Churchill of Russia. The Greek debt saga isn’t quite that unfathomable but the economic necessities continue to clash with the political realities.

Eurogroup Working Group – the expert finance officials from 17 euro zone nations who do the clever preparatory work before their finance ministers meet – will convene to today try and get the Greek debt process back on track after a ministerial meeting got nowhere on Monday and in fact ended up in an unusually public spat between its chair, Jean-Claude Juncker, and IMF Managing Director Christine Lagarde.

The Eurogroup plus Lagarde will meet again next Tuesday and there are big gaps to bridge although we intercepted the IMF chief in Manila this morning, insisting that a deal was possible, or at least that’s one way of reading her “it’s not over until the fat lady sings” quote.