MacroScope

Will rounding cents bring euro zone down?

The 18-country euro zone has had a rough ride in the past 6 years, and even with the glimmers of good news reaching the darkest corners of the debt crisis, the European Central Bank has been anything but ready to sound a crisis-over siren.

Right after ECB President Mario Draghi warned against undue optimism, the central bank has identified a new threat to the common currency’s integrity – rounding up or down small change.

Belgium plans to allow retailers to round 1 and 2-cent coins to the closest five cents, in a similar fashion as Finland and the Netherlands already do. But the ECB had harsh words against such going-it-alone moves, published in a legal opinion published on its Internet site.

“With a view to preserving the unity and integrity of the single monetary area, the ECB therefore recommends that any rounding rules are established in a harmonised manner at Union, rather than national level,” it said.

Even so, not all is lost. The ECB welcomed the fact that the smallest coins will remain legal tender in Belgium, and urged the authorities to ensure that the coins stay widely available.

Elusive Greek deal

So euro zone finance ministers conferred about Greece and Germany’s Schaeuble came out to declare significant progress although no deal yet. Eurogroup head Jean-Claude Juncker looked forward to a final settlement at the ministers’ face-to-face meeting on Nov. 12.
But a source with no particular axe to grind was much more downbeat, saying there was no real progress with Germany and the IMF at loggerheads over the need for euro zone governments and the ECB to take a haircut on the Greek bonds they hold in order to make the numbers add up.

The IMF is convinced it is the only way, Germany will not countenance it.  So all sides remain far apart and that is without even taking account of a knife-edge parliamentary vote in Athens next week on labour reforms to cut wages and severance payments, which the EU and IMF insist are a key part of a new bailout deal, but which the smallest party in the coalition government has pledged to vote against.

That leaves the two larger parties – New Democracy and PASOK – with a working majority of just nine lawmakers and on a less contentious vote on privatizations on Wednesday, a number of PASOK deputies rebelled.

An unpleasant surprise may lurk in euro zone GDP numbers

The euro zone economy may be doing far worse than most economists want to believe. That’s not good news for a central bank trying to rescue the single currency through a hotly-contested bond purchasing programme that has yet to get started.

The latest flash purchasing managers’ indexes, which cover thousands of euro zone companies, suggest the third quarter will mark the euro zone’s worst economic performance since the dark days of early 2009, according to Markit, which compiles them.

They predict the economy likely shrank by 0.6 percent in the quarter that finishes at the end of this month.

Who expects euro bonds? Look outside the euro zone

It’s already been established that economists’ predictions about the euro zone’s future hinge largely on where their employer is based. Euro zone optimists tend to work for euro zone banks and research houses, and euro zone sceptics for companies based outside the currency union.

It somewhat undermined the idea their analyses are based purely on hard-headed economics, and less on national factors.

There was an echo of that in this week’s of economists and fixed income strategists, who were asked whether they expect euro zone leaders will agree to the issuance of a common euro zone bond, as backed by new French President Francois Hollande.

The dangers of a bloated ECB balance sheet

Central balance sheets across the industrialized world have increased rapidly in response to the financial crisis, as recently noted on this blog. In Europe, the balance sheet of the ECB and the 17 national central banks that share the euro currency has grown to around 3 trillion euros after the ECB injected more than a trillion into the market in 3-year loans and loosened its collateral standards.

At above 30 percent of gross domestic product, the ECB’s balance sheet has overtaken that of the Bank of Japan, which has been grappling with deflation for some two decades and started from a much higher level. It is also bigger than that of the U.S. Federal Reserve, which has aggressively responded to two financial crises in five years by tripling the size of its balance sheet to nearly $3 trillion today.

Historically, a central bank’s job is to maintain price stability and the value of its currency. The ECB’s non-standard measures have aimed to do just that as the euro zone debt crisis threatened the viability of the euro currency. But a growing and deteriorating balance sheet also comes at a price.

An eerie euro zone calm

I don’t want to be the idiot who asked “is it all over?” … but is it all over?

Almost certainly not, is the answer. Greece is shored up for now but Portugal will probably need to follow it in seeking a second bailout and Spain, heading back into recession, will have to make deep, deep cuts over the next two years to meet EU deficit targets. Greek and French elections could easily upset the apple cart, the former producing a fractured government with less will to tread the austerity path, the latter a new president who wants to renegotiate the bloc’s new fiscal rules (though neither are guaranteed).

In Italy, a lot of faith continues to be placed in Monti but the proof of his ability to deliver the structural reforms needed to regalvanise the economy has yet to be seen. On that front, the Italian government is talking with trade unions during the week on radical reform of labour market rules, with the aim of clinching a deal next week.

Today in the euro zone

The Greek bailout is done and Spain and the EU have struck a face-saving compromise over what deficit Madrid should aim for this year, so all is well with the world. That certainly seems to be the market mood this morning with safe haven German Bund futures opening sharply lower and European stock futures pointing to further gains.
In fact, the tone is more to do with the Federal Reserve, which sounded somewhat more upbeat about the U.S. economic outlook last night and said most banks (with the exception of Citi!) had passed tough stress tests, though it’s also true that there is nothing on the euro zone horizon today to spoil the party.

Italy comes to market with its latest bond auction. Investors flush with cheap European Central Bank funds are expected to pile in, pushing three-year borrowing costs below 3 percent. Rome is taking advantage of the current benign conditions to try and sell up to six billion euros of debt.

More interesting may be tomorrow’s Spanish auction. Italian premier Mario Monti remains the euro zone’s austerity poster boy, in contrast to Mariano Rajoy. Although the new Spanish prime minister has successfully negotiated a looser deficit target with Brussels, the downside of that deal is that Madrid might come under more scrutiny, particularly if it looks like missing that softer target.

Contemplating Italian debt restructuring

This week’s evaporation of confidence in the euro zone’s biggest government debt market — Italy’s 1.6 trillion euros of bonds and bills and the world’s third biggest — has opened a Pandora’s Box that may now force  investors to consider the possibility of a mega sovereign debt default or writedown and, or maybe as a result of,  a euro zone collapse.

Given the dynamics and politics of the euro zone, this is a chicken-or-egg situation where it’s not clear which would necessarily come first. Greece has already shown it’s possible for a “voluntary” creditor writedown of  the country’s debts to the tune of 50 percent without — immediately at least — a euro exit. On the other hand, leaving the euro and absorbing a maxi devaluation of a newly-minted domestic currency would instantly render most country’s euro-denominated debts unpayable in full.

But if a mega government default is now a realistic risk, the numbers on the “ifs” and “buts” are being crunched.

Italy bond spreads signal renewed concern

Spreads between Italian and German government debt are blowing out heading into a European Union summit on Sunday that investors are hoping will come up with some action to address the continent’s sovereign debt crisis. Spreads between 10-year Italian government debt and German bonds of the same maturity widened to 398 basis points on Thursday, making for the biggest gap since at least the fourth quarter of 1996, according to Reuters data.

Andrew Wilkinson, Miller Tabak’s chief economic strategist, expands on the implications:

You have to look back to March 1996 to see the spread’s last excursion above 400 basis points. That was when Italian government was trying desperately to meet Maastricht criteria and join the euro. I’m left wondering how pleased they are with that outcome in today’s market. They never bargained for a spillover from Greece lie this. With the French/German yield spread leading the way this week it looks like pressure will continue to build in to the weekend.

Joint euro bonds: the inconvenient truth

German Chancellor Angela Merkel and French President Nicolas Sarkozy kept a distance from the idea of a common sovereign euro zone bond on this week, with France hinting only that it could be a possibility in the very distant future.

But a Reuters poll shows a growing field of investors and economists say a common bond issuance would be the best — and perhaps the only — way of solving the debt crisis. In theory, it would allow highly indebted euro zone countries to regain access to commercial markets, while providing investors a safeguard through joint liability.

More than that, those analysts think Europe’s leaders may soon have to bow down to market pressures and issue a common bond as soon as 2012 or 2013.