Risk of contagion if Greece exits euro: WestLB
What happens if Greece leaves the euro? No one can say for sure. But John Davies at WestLB, finds it difficult to envision a benign outcome.
Greece’s economy, at around $300 billion, is very small compared to the euro zone as a whole. The problem is if other countries follow suit – or are pressured in that direction by stubborn financial markets.
Such a scenario doesn’t bear thinking about because it is so horrible.
There is a good chance that the market would immediately trade Portugal towards pre-debt swap Greece levels. The next in line would certainly be Ireland and Spain.
Initially you have got to assume that spreads would become even more dislocated. As you are moving out and down the credit curve the ones with the weakest credit ratings will likely suffer worst, at least initially, because we are moving clearly into the world of the unknown and that’s precisely what the market doesn’t like.
The Greek elections have left a political vacuum that is raising speculation that the country may eventually exit the euro. Last Sunday, Greek voters punished mainstream parties that supported harsh austerity in exchange for international bailout cash. That left the Greek parliament with a jumble of minority parties that have been unable to form a government.
The leaders of Greece’s once-dominant conservative and socialist parties made a push on Friday to avert new elections and prevent a victory by a radical leftist who has promised to tear up its international bailout deal.
Inability to implement the reforms set out by international lenders amid this political void could compromise the country’s life-support bailout money and lead to a default. This could make the country’s membership of the euro increasingly unsustainable, even though those very reforms risked choking growth further in an economy suffering its fifth year of recession.
Even Germany, the key driver of growth in the euro zone, might eventually be threatened by worsening financial and economic conditions around it. And what of the bullish German Bund market which seems to know no bounds? Davies again:
Germany’s zero bound
The ultra-low rates offered by two-year German bonds reflect just how worried investors have become about the euro zone debt crisis and the continent’s sluggish economy.
Two-year German debt is currently yielding only 0.09 percent. That is less than the 0.11 percent offered by equivalent bonds in Japan – whose central bank has been grappling with deflation for some two decades. It is also below the 0.26 percent offered by similar U.S. Treasuries after the Federal Reserve more than tripled the size of its balance sheet compared to pre-crisis levels.
Elwin de Groot, senior market economist at Rabobank, expects the euro zone’s sluggish economy and intractable debt crisis to continue to favour a safety bid as long as policymakers do not take steps towards a closer fiscal union. He sees the two-year German bond yield hitting zero in three to six months and ten-year benchmark yields falling to 1.40 percent over the same period from 1.59 percent currently.
Peter Allwright of investment management firm RWC Partners goes one step further. He can envision a scenario where the German Schatz trades at significantly negative yields as the crisis unfolds.
There is going to be a huge shortage of triple A collateral in euros and if people start to price in the euro break-up scenario, people are going to be pushed into that.
“There are human beings involved” in austerity debate
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 premium investors require to hold French debt over German Bunds has also risen in the run-up to the French vote as Francois Hollande became the favourite to win.
But as economies fall deeper into recession and double-digit unemployment hurts prospects for growth, the view that austerity alone will not solve the euro zone debt crisis, seems to be gradually winning over some investors in the bond market – the heart of the crisis.
Sanjay Joshi, head of fixed income at London and Capital, says:
Netherlands at core of the crisis
The Netherlands has become the latest country to come into the firing line of the euro zone crisis.
The cost of insuring five-year Dutch debt against default jumped to its highest since January as the government’s failure to agree on budget cuts spiraled into a political crisis and cast doubt over its support for future euro zone measures.
Dutch Prime Minister Mark Rutte offered to resign on Monday, creating a political vacuum in a country which strongly backed an EU fiscal treaty.
Five-year Dutch CDS jumped 14 basis points to 133, only a whisker away from the record of 136 basis points hit on November of last year. The premium that investors require to hold 10-year Dutch bonds over their equivalent German Bunds rose to 79 basis points – its highest in 3-years.
Commerzbank’s take on Holland:
Elections could be held in September 2012 at the earliest, because the Dutch constitution prescribes a period of 80 days between the dissolution of the government and new elections. In the interim, the government would be unable to get important reforms approved by parliament. This suggests that the 3 pct (budget deficit) target will be missed in 2013 and the country’s AAA rating is at risk.
A Dutch debt auction on Tuesday will provide another test of investor appetite following Monday’s selloff.
It began with countries of Asia, Africa and Latin America, now IMF is striking Europe and it seems that Europe either is still asleep or there is a rat. Iceland, Greece, Italy, Spain, Portugal and now Holland…people of Europe .. we need to wake up, and show solidarity to countries like the above, because, as you can probably see on your own, you are the next victim of this unsatisfied moneythirsty organization and this canserlike system.Capitalism is out of control, we need to act fast…please…
U.S. housing slump: Six years and counting
Just as Americans begin to regain some hope that the housing sector might be on the mend, we get another batch of data showing the sector’s not quite there yet.
Groundbreaking on homes fell unexpectedly in March to an annual rate of just 654,000, down from 694,000 in February and well short of the 705,000 Reuters consensus forecast. Some context: permits peaked above 2.2 million in early 2006, at the apex of the housing bubble. On the bright side, permits for future construction rose to their highest level in 3-1/2 years.
In other housing data this week, homebuilder sentiment deteriorated again after posting a pretty decent rebound from the very depressed levels seen in 2011.
Regardless of the fact that the housing market is at pathetic levels historically, the builder data showed the rebound off the lows to be on track. http://bit.ly/IYSxuj
The headline number indicated an annualized decline of 44,000 for total starts, or a monthly rate of decline of 3,666. Most of that was due to multifamily starts, which are wildly volatile. Drilling down into the data, single family starts actually rose by 7,300 units in March, which is a far cry from the headline number implication that the housing market is falling apart. Single family starts normally increase in March and this March was weaker than usual, but is that a bad thing?
It seems that Wall Street analysts forget the law of supply and demand. Fewer starts mean reduced supply, especially considering the incipient rebound in housing demand, however small. Reduced supply versus increasing demand eventually leads to equilibrium, and ultimately to rising prices if those trends continue.
For insatiable markets, Spanish steps fall short
So much for the lasting power of the ECB’s 1 trillion euros in cheap bank loans. Spain is again looking like a basket-case, more because of market dynamics rather than any particular policy misteps.
Many observers have praised Spain for its willingness to implement reforms. And yet the markets have another idea. The cost of insuring debt issued by Spanish banks against default has risen sharply over the past month, as a tough budget this week did little to soothe concerns over the country’s deteriorating fiscal situation.
Default insurance for Santander is up 52 percent since March 1 to 393 basis points and the equivalent for BBVA jumped 54 percent over the same period. Both Spanish banks underperformed the Markit iTraxx senior financials index – which measures Europe’s financial institutions’ insurance, or credit default swap prices. It rose by 20 percent over the same period.
Markit analyst Gavan Nolan said a lot of the move was caused by the European Central Bank’s low-interest, three-year loan programmes, or LTROs, that have pumped money into the banking system.
They’ve actually tightened the relationship between the banks and the sovereign. So the banks have been buying sovereign debt and that has made their fortunes even more intertwined than they have previously.
Pressure on Spanish government debt has had a knock-on effect on banks. Yields on 10-year Spanish bonds this week rose to their highest since December 2011 at 5.8 percent after the Spanish Treasury had to pay more dearly to borrow in an auction.
The cost of insuring Spanish sovereign debt against default meanwhile has jumped 111 basis points to 467 bps over the past month, according to Markit data. This means it costs $467,000 annually to buy $10 million of protection against a Spanish default using a five-year CDS contract.
Ireland’s uneasy market comeback
Ireland, hailed as the poster child of euro zone austerity, is hoping to get back into the long-term bond market this year. But analysts say a hasty return could do more harm than good.
Its market position has certainly improved since it was pushed out of commercial markets and forced to seek a bailout, even though the population at large is still struggling with rigorous austerity.
Ten-year Irish yields have halved to just below 7 percent since July – before the European Central Bank began buying Spanish and Italian bonds in the secondary market to stabilise peripheral markets.
Irish CDS has also outperformed other euro zone strugglers, sliding 119 basis points to 605 bps over the same period while Spain’s climbed 168 basis points and Italy’s jumped 196 basis points, according to Markit data.
And Irish 10-year bonds have made total returns of 12.1 percent so far this year, second only to Italy in the euro zone, Thomson Reuters data shows.
A recovery in Europe? Really?
There’s a sense of relief among European policymakers that the worst of the euro zone’s crisis appears to have passed. Olli Rehn, the EU’s top economic officials, talked this week of a “turning of the tide in the coming months”. Mario Draghi, the president of the European Central Bank, speaks of “sizeable progress” and “a reassuring picture”.
At last week’s spring summit, EU leaders couldn’t say it enough: “This meeting is not a crisis meeting … it’s not crisis management,” according to Finnish Prime Minister Jyrki Katainen. All the talk is of how the euro zone’s economy will recover in the second half of this year.
But for the 330 million Europeans who make up the euro zone, the outlook has, if anything, darkened. As euro zone governments deepen their commitment to deficit-cutting, and rising oil prices mean higher-than-expected inflation, households can’t be counted on to drive growth. Not only did housing spending fall 0.4 percent in the October to December period from the third quarter, but unemployment rose to its highest since late 1997 in January.
Joblessness is reaching shameful levels in southern Europe. In Greece, unemployment rose to a new record high of 21 percent in December and to 23 percent in Spain in January. Even in wealthy, northern Europe, the number of people out of work has started to rise in France, the Netherlands and Germany.
Just over half of the euro zone‘s economic output is generated by domestic consumer spending, but demand for goods looks chronically weak and fiscal austerity is aggravating the situation. Euro zone governments, desperate to distinguish themselves from debt-stricken Greece, are completely unwilling to step in and spend. The European Commission, persuaded mainly by Germany that fiscal discipline will lift economic growth, is on their backs to get their deficits within the 3 percent level of GDP by the end of 2013.
“The case against Europe’s growth strategy is that it is all supply and no demand,” said Philip Whyte, a senior research fellow at the Centre for European Reform. “Fiscal policy is being tightened too rapidly. The more certain EU countries do to balance their budgets, the more output contracts,” he said in a recent paper.
So where will growth come from? The ECB’s Draghi said this week he is counting on foreign demand. Emerging Asia and a stronger recovery in the United States might help pull the euro zone out of its slump. But with Germany responsible for almost 40 percent of the euro zone’s exports, a wider tide of prosperity across the currency area looks unlikely.
France: More like Italy than Germany?
In the more than two years that have passed since the start of Europe’s financial crisis, France has consistently aligned itself with Germany in pushing for greater austerity in so-called “peripheral countries” like Greece, Portugal, Spain and Italy. German Chancellor Angela Merkel even took the rare and somewhat awkward step of publicly campaigning for French President Nicolas Sarkozy.
But a closer look at the country’s debt profile suggests France may be misjudging its own underlying financial conditions. Even beyond French banks’ considerable exposure to southern European sovereign bonds, analysts say the economic backdrop is remarkably similar to nations that have run into trouble.
Writes Christoph Weil of Commerzbank in a research note:
France has the same problems as the euro periphery. The French economy is struggling with a massive loss of competitiveness and rising unemployment, while the consolidation of government finances is progressing at a sluggish pace. [...]
The French government has financed spending via ever-higher borrowing. In the 9 years since 2002, the French finance minister has exceeded the deficit limits of the Maastricht Treaty on 6 occasions. As a result, France is now deeply in the red. While sovereign debt was under the 60% of GDP threshold at the beginning of monetary union, it had risen to 85% by the end of 2011.
Oh la la. Or should we say, mamma mia?
If France is like Italy, then Britain and the US are like Greece!
Just a few figures for those who are desperately trying to spread the contagion to France (how many French CDSs has Commerzbank bought recently? That’d be interesting to disclose):
French GDP growth in 2011: 1.7%. That’s almost DOUBLE that in the UK (0.9%), even though Britain is benefiting from a competitive devaluation of the pound. France has actually recovered all of the lost GDP since the pre-crisis peak. Italy, by comparison, grew only 0.4% in 2011.
France has also beaten its deficit reduction targets: budget deficit will be at 5.4% in 2011, compared to a previous forecast of 5.7%. Of course, that’s WAY below the UK budget deficit at 8% and also below the US deficit.
As to overall debt, French debt of 85% is comparable to Britain’s 83% (British public debt grew much faster since the financial crisis started and will overtake France’s next year), and is also much below US debt, which has hit 100% of GDP this year, not a far cry from Italy’s 120%.
And yes, German growth was higher in 2011. But nobody seems to remember than in 2009, when German GDP was freefalling at -5%, France’s recession was only a mild 2%.
So please, if you pretend to have “a closer look” at France’s debt profile, try and be a bit more complete in your assessment, and not just superficially brush on an issue. This is Reuters, not the New York Post.
Europe’s clear and present danger to U.S. economy
Jason Lange contributed to this post.
Suddenly the shoe is on the other foot. The financial crisis of 2007-2008 had its roots in the U.S. banking system and then spread to Europe. Now, it’s Europe’s political debacle that threatens economic growth in the United States.
A recent raft of better U.S. economic data, including a steep drop in weekly jobless claims reported on Thursday, have pointed to a swifter recovery. But such signals seem a bit futile when there’s a risk of another major global financial meltdown lurking.
Yet just what is the likely impact of the euro zone’s morass on the United States? Economists at Goldman Sachs ran some figures through their models, and the results were not pretty: overall, Europe’s crisis is likely to shave a full percentage point off U.S. economic growth. In a world where economists have come to expect the “new normal” for U.S. growth to be around 2.5 percent, that could mean the difference between a decent recovery and one that is highly fragile and vulnerable to shocks.
Goldman’s analysis focuses on so-called counterparty risk – the exposure of U.S. financial institutions to European lenders.
Euro area banks–including both the head office and the US subsidiaries–currently hold about $1.8 trillion in claims on US counterparties, or 3.3% of total US debt outstanding. If they were to cut their lending to US residents by 25%–an admittedly arbitrary number but roughly equal to the peak pace seen in the 2008-2009 financial crisis–this would imply a 0.8% hit to US debt outstanding. Prior research suggests that such a hit could shave 0.4 percentage points off US growth, all else equal.
Some pullback is already visible in the Fed’s senior loan officers’ survey. In the fourth quarter of 2011, a net 22.7% of the US subsidiaries of foreign banks indicated a tightening of C&I lending standards; in the second quarter, a net 18.2% had indicated an easing of standards. When adjusted for the 20% C&I loan market share of foreign banks and using the historical relationship between C&I lending standards and GDP growth, this implies an impact on GDP growth of about -0.2 percentage points as of the Q4 survey, compared with +0.2 points as of the Q2 survey.
Of course, the behavior of Euro area banks forms only one part of the potential financial spillovers from the Euro crisis. We continue to think that the European crisis will subtract around 1 percentage point from US growth over the next year, with banking spillovers accounting for about half of this impact.
The findings corroborate the research of Princeton University professor Hyun Song Shin, who has done joint work with Goldman’s chief economist Jan Hatzius in the past. Shin argued in an IMF paper last month that the notion that the United States could be insulated from a European banking debacle is naïve.
debt relief by more debt added faster…faster..faster.faster…
the math is compelling.
the greeks must default…default..default.default…
printing is the world’s only current option. if, and only if, the major currencies agree to unified manipulation of currencies, and stick to it, can the pain inflicted by fiat foolishness be gentled enough to allow the real people to be ok.
p.s. the printers must agree to a fixed ‘flow’, but that’s another story.