MacroScope

Back to banking union

The G8 produced little heat or light on the state of the world economy but if there was one clarion call it was for the euro zone to get on with forming a banking union – the last major initiative needed to draw a line under the euro zone debt crisis.

With the European Central Bank effectively underwriting the bloc’s governments with its bond-buying pledge, a cross-border mechanism to recapitalise or wind up failing banks would do the same for the financial sector.

The trouble is, not unreasonably, Berlin does not want to fall liable for the failure of a bank in a weaker country. Instead, it is pressing for a “resolution board” involving national authorities to take decisions on winding up failed banks, which sounds like the onus would remain on governments to sort out their own banks rather than pooling risk which would convince investors that a proper backstop was in place.

In other words, the “doom loop” of weak banks and sovereigns weighing on each other would be unbroken.

U.S. President Barack Obama, whose administration has been urging progress on this front, is in Berlin today for a lot of ceremony and some talks with Angela Merkel.

Mystery of the missing Fed regulator

It’s one of those touchy subjects that Federal Reserve officials don’t really want to talk about, thank you very much.

For nearly three years now, no one has been tapped to serve as the U.S. central bank’s Vice Chairman for Supervision. According to the landmark 2010 Dodd-Frank bill, which created the position to show that the Fed means business as it cracks down on Wall Street, President Obama was to appoint a Vice Chair to spearhead bank oversight and to regularly answer to Congress as Chairman Ben Bernanke’s right hand man.

For all intents and purposes, Fed Governor Daniel Tarullo does that job and has done it for quite some time. He’s the central bank’s regulation czar, articulating new proposals such as the recent clampdown on foreign bank operations, and he keeps banks on edge every time he takes to the podium. But he has not been named Vice Chair, leaving us to simply assume he won’t be.

from Global Investing:

Show us the (Japanese) money

Where is the Japanese money? Mostly it has been heading back to home shores as we wrote here yesterday.

The assumption was that the Bank of Japan's huge money-printing campaign would push Japanese retail and institutional investors out in search of yield.  Emerging markets were expected to capture at least part of a potentially huge outflow from Japan and also benefit from rising allocations from other international funds as a result.  But almost a month after the BOJ announced its plans, the cash has not yet arrived.

EM investors, who seem to have been banking the most on the arrival of Japanese cash, may be forgiven for feeling a tad nervous. Data from EPFR Global shows no notable pick-up in flows to EM bond funds while cash continues to flee EM equities ($2 billion left last week).

Cyprus Plan B – phoenix or dodo?

They’ve only been looking for it for a day but Cyprus’s Plan B has already taken on mythical status. A myth it might remain.

Ideas being floated include nationalizing the pension fund (back of the envelope calculations suggest that will raise less than a billion euros) and issuing bonds underpinned by future natural gas revenues (but no one is really sure how much they are worth). So to avoid default it still looks like the Cypriots may have to return to the bank levy they rejected so decisively in parliament on Tuesday, to raise the 5.8 billion euros the euro zone is demanding in return for a bailout.

Finance minister Sarris is still in Moscow hoping for some change out of the Russians and is out this morning saying discussions are ongoing about banks and natural gas.

Euro zone triptych

Three big events today which will tell us a lot about the euro zone and its struggle to pull out of economic malaise despite the European Central Bank having removed break-up risk from the table.

1. The European Commission will issue fresh economic forecasts which will presumably illuminate the lack of any sign of recovery outside Germany. Just as starkly, they will show how far off-track the likes of Spain, France and Portugal are from meeting their deficit targets this year. All three have, explicitly or implicitly, admitted as much and expect Brussels to give them more leeway. That looks inevitable (though not until April) but it would be interesting to hear the German view. We’ve already had Slovakia, Austria and Finland crying foul about France getting cut some slack. El Pais claims to have seen the Commission figures and says Spain’s deficit will will come in at 6.7 percent of GDP this year, way above a goal of 4.5 percent. The deficit will stay high at 7.2 percent in 2014, the point so far at which Madrid is supposed to reach the EU ceiling of three percent.

2. Banks get their first chance to repay early some of the second chunk of more than a trillion euros of ultra-cheap three-year money the ECB doled out last year. First time around about 140 billion was repaid, more than expected, indicating that at least parts of the euro zone banking system was returning to health. Another hefty 130 billion euros is forecast for Friday. That throws up some interesting implications. First there is a two-tier banking system in the currency bloc again with banks in the periphery still shut out. Secondly, it means the ECB’s balance sheet is tightening while those of the Federal Reserve and Bank of Japan continue to balloon thanks to furious money printing. The ECB insists there is plenty of excess liquidity left to stop money market rates rising much and a big rise in corporate euro-denominated bond sales helps too. But all else being equal, that should propel the euro yet higher, the last thing a struggling euro zone economy needs.

Super, or not so super, Thursday

For those who thought the euro zone had lost the power to liven things up, today should make you think again.

ITEM 1. The European Central Bank meeting and Mario Draghi’s hour-long press conference to follow. Rarely has a meeting which will deliver no monetary policy change been so pregnant with possibilities.

Draghi, the man tasked with becoming the European bank regulator on top of all his other tasks, will face some searing questioning on his time as Bank of Italy chief and what he knew about the disaster that has befallen the country’s oldest bank, Monte dei Paschi.

Market/economy disconnect?

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.

Irish setback

We’ve been saying for some time that while the immediate heat may be off the euro zone, therein lies a danger – that policymakers will relax their efforts to remould the bloc into a tougher structure that can withstand future crises, and possibly even allow this crisis to flare back into life.

Exhibit A has been the apparent backsliding on what we thought was a concrete plan to allow the euro zone rescue funds to recapitalize banks directly from next year, thereby removing the onus on highly indebted governments to do so. Over the weekend we got Exhibit B courtesy of a Reuters exclusive.

We reported that the European Central Bank had rejected Ireland’s solution to avoid the crippling cost of servicing money borrowed to rescue its failed banking system – debt servicing would amount to around 3 billion euros a year for the next 10 years. Dublin wanted to convert the promissory note into long-term bonds. The ECB decided last week that that crossed its red line of monetary financing.

Europe and the danger of soft-pedalling

No one really questions Angela Merkel’s supremacy in Germany but losing the key state of Lower Saxony in a Sunday election, albeit by the narrowest of margins, means we’ll have to put on ice proclamations that her re-election for a third term in the autumn is now merely a procession. The centre-left SPD and Greens won the state by a single seat. Merkel and others will speak about the result today. What it probably does affirm is that the Chancellor will be extremely cautious about agreeing to more euro zone crisis fighting measures before the national election is safely out of the way.

We’ve been here before. When the drumbeat of market pressure eases, euro zone policymakers have tended to lose their sense of urgency. Today’s meeting of euro zone finance ministers, the first of the year, could be a case in point. The agenda lists “progress” on Cyprus, Spain, Ireland, Portugal and Greece with no decisions expected.
The meeting is set to anoint Dutch Finance Minister Jeroen Dijsselbloem as its new chairman after France dropped its objections on Sunday. He will attend the final press conference so it will be interesting to hear his pitch.

The most important area of debate will be the euro zone’s rescue fund and its ability eventually to recapitalize struggling banks directly, thereby breaking the “doom loop” whereby weak governments drive themselves further into debt by propping up listing banks while the lenders are stuffed with that government’s bonds which are liable to lose value. EU leaders seemed pretty clear at last June’s summit that this would be done but there are now suggestions that governments will remain on the hook to at least some extent. That would be a very significant backward step.

Will bank lending finally start to rise?

Big news over the weekend was the world’s banks being given an extra four years to build up their cash piles, and given more flexibility about what assets they can throw into the pot. This is a serious loosening of the previously planned regime and could have a significant effect on banks’ willingness to lend and therefore the wider economy.

For over two years, banks have complained that they can’t oil the wheels of business investment and consumer spending while being forced to build up much larger capital reserves to ward off future financial crises. That contradiction has now been broken (a big win for the bank lobbyists) and the impact on economic recovery could be profound.

However, there are no guarantees. Banks, in Europe at least, have also insisted that lending has remained low because there isn’t the demand for credit from business and households. If that’s true, increased willingness to lend might not be snapped up.