MacroScope

Is everything falling into place to at least declare a moratorium in the euro zone debt crisis?

Well the ESM rescue fund getting a go-ahead from Germany’s consitutional court and the Dutch opting to vote for the two main pro-European parties, following Mario Draghi’s confirmation last week that the European Central Bank would buy Spanish and Italian bonds if required, means things are starting to look a little rosier.

The risks? Next spring’s Italian election, and what sort of government results, casts a long shadow and it is just about conceivable that Spain could baulk at asking for help, given the strings attached, although the sheer amount of debt it needs to shift by the end of the year will almost certainly force its hand. If the Bundesbank mounted a guerrilla war campaign against the ECB bond-buying programme it could well undermine its effectiveness. That is a big if given broad German political support for the scheme. Key countries remain deep in recession with little prospect of returning to growth because of the imperative to keep eating away at their debt mountains, which could eventually trigger a dramatic public reaction. France could well get dragged into that category.

More generally, there is the previous history of this crisis which has shown that when the heat is lifted, policymakers can take their foot off the pedal. Surely they’ve learned that lesson by now, I hear you cry. Well, Spanish premier Mariano Rajoy was out yesterday saying he was still studying the price to be paid for seeking help but improved market conditions may make aid unnecessary. Spanish 10-year yields have tumbled from around 7.5 percent to 5.7 since Draghi first showed his hand in late July. That’s still too high for Madrid to manage indefinitely. After regional elections in late October, Rajoy may well jump.

Everything achieved in the past week has been about buying policymakers time to put the permanent structures in place to make the euro zone viable in perpetuity. None of it amounts to a permanent solution. Evidence yesterday of a growing row about the scope and powers of a cross-border banking union and a distinctly mixed reception for Barroso’s call for a properly federal Europe shows there’s a lot still to be done. The most profound parts of a banking union, particularly a joint deposit guarantee scheme to prevent bank runs, are not even on the table yet and are likely to take years to introduce.

Another blockbuster chapter in the euro zone epic.

Top billing today goes to Germany’s constitutional court, which is expected to give a green light to the euro zone’s permanent rescue fund, the ESM, albeit with some conditions imposed in terms of parliamentary oversight. The ruling begins at 0800 GMT. If the court defied expectations and upheld complaints about the fund, it would lead to the mother of all market sell-offs and plunge the euro zone into its deepest crisis yet.

Without the ESM, the European Central Bank’s carefully constructed plan to backstop the euro zone would be in tatters. It has said it will only intervene to buy the bonds of the bloc’s strugglers if they first seek help from the rescue fund and sign up to the strings that will be attached. The first rescue fund, the EFSF, could perhaps fill this role for a while but its resources are now threadbare, so without the ESM, markets would scent blood.

The Dutch go to the polls but with the hard-left Socialists seemingly losing support, the ruling Liberal party and moderate centre-left Labour are  neck-and-neck and look likely to form a coalition government committed to tight debt control and, more importantly, to the euro zone. So unless voters are lying to pollsters, some of the drama has leached out of this particular saga although it could take some considerable time to put a coalition together.

So the euro zone debt crisis morphs again and there is a hint of schadenfreude about the Dutch, who lectured and hectored the Greeks, now falling into the same mire.

The Dutch premier, Mark Rutte, will probably try to cobble together an unholy alliance in parliament in order to meet an April 30 EU deadline for it to present budget plans for the next year. But with elections not until late June at the earliest, there will be an unnerving period of vacuum for the markets and no guarantee that opposition parties will play ball and allow a budget to be put together.

Given all that, today’s Dutch bond auction, not normally a cause for alarm or excitement, is thrown into sharp relief. Expect yields to spiral although the small amount on offer means the paper will be sold. Italy is selling zero-coupon and inflation-linked bonds while Spain,  which remains front and centre despite the Netherlands’ travails, will probably see borrowing costs double when it sells up to 2 billion euros of 3- and 6-month treasury bills. Spanish 10-year yields poked above the pivotal 6 percent level again yesterday as the Dutch government collapse rocked markets. The Bank of Spain confirmed on Monday that a new recession has taken hold.

Big debt test for Italy which will sell 8 billion euros or more of longer-dated bonds. A short-term T-bill sale went okay on Wednesday but a day before, the secondary market reacted negatively to a sale of zero-coupon and inflation-linked bonds, pushing Italian yields higher.

The glut of ECB three-year money has ensured Italian and Spanish auctions have sailed out of the door so far this year but there will be no more largesse from the central bank so be on the look out for signs of that support fading. Analysts expect this sale to go well with Italian banks wading in again.

Euro zone money supply data on Wednesday showed Spanish and Italian banks stocked up on government bonds in February – and that was before the ECB’s second instalment of money creation to the tune of 500 billion euros. So bond sales should be underpinned for some time yet though it is clear that the central bank has bought policymakers time rather than solved the root problems.