MacroScope

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?

The Cypriot saga has thrown the spotlight on Slovenia, which is also a small euro zone country struggling with an over-burdened banking sector.

Slovenia’s mostly state-owned banks are nursing some 7 billion euros of bad loans, equal to about 20 percent of GDP, underpinning persistent speculation that the country might have to follow other vulnerable euro zone countries in seeking a bailout.

According to Standard Bank’s head of emerging market research Tim Ash:

The latest crisis in the euro zone, this time in Cyprus, continues to raise questions as to possible contagion effects throughout the region, and in particular which economies could be next.

A slightly bigger than forecast 5.7 percent rise in sales of new homes in September reported by the National Association of Realtors on Wednesday lends credibility to September’s jump in housing starts, but appears neutral for Federal Reserve monetary policy discussions.

The jump in new home sales seems to have largely justified the 11 percent jump in September housing starts, says Decision Economics senior economist Pierre Ellis. The inventory of houses for sale at the end of September rose just 1.4 percent, from the end of August and the months’ supply fell to 4.5 months from 4.7 months, he added.

Thus, the increased production of houses seems not to have involved any “over-exuberant optimism” – and the impact if demand were suddenly to evaporate would be contained, he said. “Healthy skepticism seems to prevail in builderland,” Ellis observes.

The inventors of democracy and its greatest 18th century champions both go to the polls this weekend. Greek and French voters will try to elect governments they hope will help release their economies from the grips of the euro zone debt crisis.

While exercising their democratic vote, Europeans will also be contemplating another key issue: their basic economic survival.

That is why the debate about austerity versus growth has become so important.

Financial markets see fiscal discipline as crucial to get the euro zone’s debt burden back to sustainable levels. They are going into the Greek elections favoring triple-A rated bonds over peripheral counterparts.

The U.S. Treasury bond market may be in for a bit of a rollercoaster ride over the near term as each new day seems to bring another deluge of debt, with the government trying to clear out all it can before the holidays. The Treasury on Wednesday sold $13 billion of reopened 30-year bonds, and investors dove in to scoop up the debt even though yields are hovering near record lows. Wednesday’s sale was the third of seven debt sales over an eight-session period, in which the Treasury is expected to move a total of $177 billion of paper. The rush of paper could give Treasuries a shaking.

Priya Misra and Marcus Huie, strategists at Bank of America Merrill Lynch, said in a research note:

The next week could see some choppy price action in the Treasury market. And not just because of concerns about Europe. Treasury investors have to absorb a very heavy supply calendar over the next week. Normally supply across the curve is spread out over a month, but the Treasury moved up its end-of-month auctions to avoid auctioning in the holiday week. We believe that short positioning of investment funds and foreign demand should help absorb the supply, but the market will likely attempt to set up before each auction. This should result in greater intra-day volatility in Treasuries.