MacroScope

Euro zone may struggle with its own Lost Decade

Additional Reporting by Andy Bruce and polling by Rahul Karunakar and Sumanta Dey.

As Europe’s crisis drags on, the prospect of a Japanese-style lost decade of economic malaise is becoming increasingly real, according to a new poll. Half of the bond strategists and economists surveyed by Reuters are now expecting just such an outcome.

Many market participants have dismissed the fall of two-year German bond yields below their Japanese counterparts as being merely a result of a crisis-fueled flight to quality bid. Two-year German yields are now close to zero, offering returns of only 0.02 percent. By contrast, equivalent Japanese bonds are yielding 0.11 percent.

But a significant portion of analysts in a Reuters poll see something more sinister in the rapid narrowing of the premium investors require to hold German debt over Japanese bonds. One half of those polled – 12 out of 24 – said it is likely the euro zone is close to entering a period of prolonged low or no growth and inflation and low interest rates, with the other half saying it was unlikely.

According to Stephen Lewis, chief economist at Monument Securities:

I don’t really see an early end to the financial crisis in the euro zone. I think it’s very unlikely that Germany and the other countries will see eye to eye in the course of this year. That’s going to keep the euro zone economy looking very weak for the next several quarters.

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.

“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.

Dancing on the edge of a (fiscal) cliff

With hundreds of billions worth of stimulus measures set to expire on Jan. 1, investors are all too aware that the United States is hurtling toward what economists are calling “a fiscal cliff.” It’s just that most seem to think Congress will execute one of its typical last-minute, hairpin turns to avoid plunging the economy over the edge.

As Russ Koesterich, global chief investment strategist at iShares told Reuters recently, “people are worried but they feel some sort of fix will get done.” Certainly the equity and bond markets back him up: the S&P 500 is up a healthy 12.7 percent this year while benchmark 10-year Treasury yields remain pinned beneath 2 percent.

Ethan Harris at Bank of America-Merrill Lynch isn’t so sure. After all, we’re talking about the same group of politicians who nearly forced the United States to default last year and earned it a credit downgrade from S&P in the process. This time, Republicans and Democrats will have just seven weeks to stitch up a deal, and they’ll have to do it while the wounds inflicted by a brutally negative a presidential election campaign are still fresh.

Tumultuous euro zone week

A week where every facet of the euro zone debt saga will come from all angles.

The major events are the French presidential run-off and Greek general elections on Sunday, May 6.
 
In the former case, a likely socialist Francois Hollande victory could cause some market jitters given his rhetoric about the world of finance. But we’ve looked at this pretty forensically and actually there may not be much to scare the horses. Yes he is making growth a priority (but even the IMF is saying that’s a good idea) yet his only fiscal shift is to aim to balance the budget a year later than Sarkozy would. And, contrary to some reports, he is not intent on ripping up the EU’s new fiscal rules. And of course, the bond market will only allow so much leeway.

If the two main Greek parties – PASOK and New Democracy – fail to win enough votes to govern together, they may have to turn to a fringe anti-bailout party which would put a big question mark over Athens’ ability to stick with the austerity terms demanded by its international lenders.

Even if fears about a hard Greek default or even euro exit result, the threat of contagion looks far smaller. With creditors already having taken a massive haircut, most non-Greek banks completely out or at least having written down anything they hold, a 500 billion euros rescue fund shortly in place and the IMF raising an extra $430 billion of its own, the power Greece has to start a domino effect in the euro zone is very much diminished.

A curate’s egg — good in parts

An action-packed weekend with both good and bad news for the euro zone, which may — net — leave its prospects little clearer.

Item 1: The IMF came up with $430 billion in new firepower to contain the euro zone-led world economic crisis, although some of the money will only be delivered by the BRICS once they have more sway at the Fund. Nonetheless, the figure at least matches expectations and could give markets pause for thought. The official line is that it is for non-euro countries caught up in the maelstrom but no one really believes that. If a Spain is teetering, IMF funds will be there. Together with the 500 billion euros rescue fund set up by the euro zone, there is still barely enough to ringfence both Italy and Spain if it came to it. But will it come to it?

Item 2: Socialist Francois Hollande came out top in the first round of the French presidential election and is now a warm favourite to win. Some fear that could weaken the Franco-German motor which must be humming smoothly if further crisis-fighting measures are to be convincing. Others say he is essentially a centrist who, either way, will be constrained by the realities of the euro zone situation. Domestically, his focus on tax rises over spending cuts and a slower timetable for cuts could drive up French borrowing costs. Attempts by Hollande and President Nicola Sarkozy to woo the substantial votes that went to the far right and far left could lead to some nerve-jangling campaigning messages for the markets to swallow in the run-up to the May 6 second round.

IMF crisis funds: Why nobody really cares

With reporting from Steven C. Johnson and Nick Olivari

A lot of time and money is spent on high-profile multilateral gatherings like this weekend’s International Monetary Fund meeting in Washington. The central story this time is the Fund’s effort to raise more funds (no pun intended), which appears to have been successful as G20 nations committed more than $430 billion in new funds.

French Finance Minister François Baroin, speaking to reporters at a press briefing on the sidelines of the IMF meeting, greeted the news with optimism:

Clearly, the reinforcement of the IMF with more than $400 billion in new resources and its effects on confidence will contribute to financial stability in the euro zone.

Spain: ¿Cómo se dice “contagion”?

It was not a good day for Spain.

The euro zone’s fourth largest economy had to pay dearer to borrow through medium-term bonds, a sign that concerns over the country´s fiscal problems was curbing appetite for its debt. It sold 2.6 billion euros of 2015, 2016 and 2020 paper – at the low end of the target range.

In contrast, Portugal’s 1 billion euros sale of 18-month treasury bills was a successful test of market appetite for the longest-dated debt since it took an international bailout. Appetite for short-dated paper has been especially supported by the one trillion euros of cheap three-year European Central Bank funding injected into the financial system since December.

The problem is that Spain is the latest country to come into the firing line of the euro zone debt crisis. This week’s tough budget was not enough to calm investor nerves and many fear too much austerity could choke an already struggling economy where unemployment rose to a staggering 22.9 percent in the fourth quarter of 2011 – the highest in the European Union. Meanwhile, the government expects Spain’s public debt to jump in 2012 to its highest since at least 1990.

Europe’s triple threat: bad banks, big debts, slow growth

The financial turmoil still dogging Europe is most often described as a debt crisis. But sovereign debt is only part of the problem, according to new research from Jay Shambaugh, economist at Georgetown’s McDonough School of Business. The other two prongs of what he describes as three coexisting crises are the region’s troubled banks and the prospect of an imminent recession.

These problems are mutually reinforcing, and require a more forceful policy response than the authorities have delivered to date. In particular, Shambaugh advocates using tax policy to lower labor costs, fiscal stimulus from those economies strong enough to afford it, and more aggressive action from the European Central Bank:

It is possible that coordinated shifts in payroll and consumption taxes could aid the painful process of internal devaluation. The EFSF could be used to capitalize banks and to help break the sovereign / bank link. Fiscal support in core countries could help spur growth.  Finally, the ECB could provide liquidity to sovereigns and increase nominal GDP growth as well as allow slightly faster inflation to facilitate deleveraging and relative price adjustments across regions.

Greek debt – remember the goats

Greece’s creditors have essentially let it off the hook by overwhelmingly agreeing to take a 74 percent loss.  So what better time to  remember  one of the first times Athens got in trouble with paying its debts.

In 490 BC, the bucolic plains before the town of Marathon were the site of a bloodbath. Invading Persians  lost a key battle against Greeks, who were led by the great Athenian warrior Kallimachos, aka Callimachus.

The trouble is, Kallimachos shares some of the difficulty with numbers that  modern Greek leaders appear to have.  Before launching himself upon the  Persians,  he  pledged to sacrifice a young goat to the Gods for every enemy that was killed.