MacroScope

Irish setback

We’ve been saying for some time that while the immediate heat may be off the euro zone, therein lies a danger – that policymakers will relax their efforts to remould the bloc into a tougher structure that can withstand future crises, and possibly even allow this crisis to flare back into life.

Exhibit A has been the apparent backsliding on what we thought was a concrete plan to allow the euro zone rescue funds to recapitalize banks directly from next year, thereby removing the onus on highly indebted governments to do so. Over the weekend we got Exhibit B courtesy of a Reuters exclusive.

We reported that the European Central Bank had rejected Ireland’s solution to avoid the crippling cost of servicing money borrowed to rescue its failed banking system – debt servicing would amount to around 3 billion euros a year for the next 10 years. Dublin wanted to convert the promissory note into long-term bonds. The ECB decided last week that that crossed its red line of monetary financing.

The Irish government responded to our exclusive on Sunday by saying it would change its proposal, saying a failure to resolve it would have a “potentially catastrophic effect”. What is certainly true is that it would make exiting its bailout this year – which looked like it was almost a certainty after recent forays into the bond market – much more complicated. The next payment falls due at the end of March.

Irish debt yields have plunged in recent months but as the head of the country’s debt agency said last week, markets have “to a greater or lesser extent” priced in a promissory note deal.

Europe and the danger of soft-pedalling

No one really questions Angela Merkel’s supremacy in Germany but losing the key state of Lower Saxony in a Sunday election, albeit by the narrowest of margins, means we’ll have to put on ice proclamations that her re-election for a third term in the autumn is now merely a procession. The centre-left SPD and Greens won the state by a single seat. Merkel and others will speak about the result today. What it probably does affirm is that the Chancellor will be extremely cautious about agreeing to more euro zone crisis fighting measures before the national election is safely out of the way.

We’ve been here before. When the drumbeat of market pressure eases, euro zone policymakers have tended to lose their sense of urgency. Today’s meeting of euro zone finance ministers, the first of the year, could be a case in point. The agenda lists “progress” on Cyprus, Spain, Ireland, Portugal and Greece with no decisions expected.
The meeting is set to anoint Dutch Finance Minister Jeroen Dijsselbloem as its new chairman after France dropped its objections on Sunday. He will attend the final press conference so it will be interesting to hear his pitch.

The most important area of debate will be the euro zone’s rescue fund and its ability eventually to recapitalize struggling banks directly, thereby breaking the “doom loop” whereby weak governments drive themselves further into debt by propping up listing banks while the lenders are stuffed with that government’s bonds which are liable to lose value. EU leaders seemed pretty clear at last June’s summit that this would be done but there are now suggestions that governments will remain on the hook to at least some extent. That would be a very significant backward step.

Glimmer of Greek hope

There are signs of headway from Athens where we have just snapped a government source saying the IMF accepts Greek debt is “viable” if it falls to 124 percent of GDP in 2020, rather than the 120 that it had previously decreed was the maximum sustainable level.. The source said fresh measures have been found to reduce debt to 130 percent of GDP by 2020, leaving another 10 billion euros to be covered.

At the latest failed meeting of euro zone finance ministers on Tuesday, we confirmed that the EU/IMF/ECB troika had calculated Greek debt would only fall to 144 percent of GDP in 2020 without further measures, meaning roughly 50 billion euros needed to be knocked of Greece’s debt pile. A report circulated at the meeting concluded (apologies for the number soup) that debt could only be cut to 120 percent of GDP in eight years if euro zone government agreed to take a writedown on their loans, which they will not do for now.

If the IMF will now accept 124 percent as a target that means 20 percentage points of GDP – about 40 billion euros – would have to be lopped off Greece’s debt pile. If they are now only 10 billion short, then measures amounting to 30 billion have been found. It’s hard to believe that could have come from the Greek side which has already slashed to the bone, so maybe some or all of the options we know are on the table — a Greek debt buyback at a sharp discount, lowering the interest rate and lengthening terms on the loans and the ECB foregoing profits on its Greek bondholdings – have been agreed to.

The Greek “cliff”

Some key positions were staked out on Greece over the weekend – ECB power-behind-the throne Joerg Asmussen became the first euro policymaker to say on the record that euro zone finance ministers meeting on Tuesday would be intent only on finding a deal to tide Greece over the next two years. But IMF chief Christine Lagarde told us in an interview that she would push for a permanent solution to Greece’s debts to avoid prolonged uncertainty and further damage to the Greek economy.
  
Sounds like those two positions could be mutually exclusive. However, it may be that something like a behind-the-scenes pledge from the German government that it will act decisively after next year’s election will keep the IMF on board.

Eurogroup chief Jean-Claude Juncker said at the weekend that intensive work was being done on a compromise with the IMF and progress was being made, after the euro zone sherpas put their heads together on Friday. And even hardline German Finance Minister Wolfgang Schaeuble said a deal had to be struck on Tuesday and would be. Juncker and Lagarde clashed last week over his suggestion that Greece should be given an extra two years, to 2022, to get its debt/GDP ratio down to 120 percent, the level the IMF has decreed is the maximum sustainable. Lagarde looked surprised and firmly rejected the idea.

IMF officials have argued that some writedown for euro zone governments is necessary to make Greece solvent but Germany has repeatedly rejected the idea of taking a loss on holdings of Greek debt, saying it would be illegal. 
Among ideas under consideration to plug the funding gap are further reducing the interest rate and extending the maturity of euro zone loans to Greece, a possible interest payment holiday and bringing forward loan tranches due at the end of the programme, according to euro zone sources.

Greek show still on the road

The Greek government pulled it off last night, winning parliamentary approval for an austerity package which offers yet more deep spending cuts, tax rises and measures to make it easier and cheaper to hire and fire workers. But boy was it tight. With the smallest member of the coalition rejecting the labour measures, Prime Minister Antonis Samaras carried the day by just a handful of votes. The overall budget bill is expected to be pushed through parliament on Sunday.

So the show remains on the road and this government has shown more resolve than its predecessors which may buy it some goodwill from its lenders. Attention today turns to the monthly policy meeting of the European Central Bank, a key player in negotiations to put Greece’s debts back on a sustainable path.  Mario Draghi could well rule out taking a haircut on the Greek bonds it holds, something the IMF has pushed it and euro zone governments to do but which Germany and others won’t countenance.  However, the ECB could forego profits it has made on Greek bonds it bought at a steep discount. Those profits have to be funneled through national euro zone central banks and would only be realized when the bonds mature but it would still help.

Greece is set to get two more years to make the cuts demanded of it and EU economics chief Olli Rehn told us yesterday that lengthening the maturities on official loans to Greece and lowering interest rates on them could be done but a haircut was out. There is the possibility of a meeting of the Eurogroup Working Group (the expert officials who prepare for euro zone finance ministers’ meetings) but it seems less likely that a deal will be struck at next Monday’s Eurogroup meeting, with officials now giving themselves until the end of November to come up with something. There were suggestions that Washington had urged big decisions to be put off until after the presidential election. True or not, that roadblock is now out of the way.

The vote that counts for markets

The American people have spoken but for the markets the votes of 300 Greeks could be of even more importance in the short-term. German Bund futures have opened flat, not really reacting to Obama’s victory, while European stocks have eked out some early gains.
       
We await a knife-edge parliamentary vote in Athens 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, a number of PASOK deputies rebelled. Ratcheting up the pressure is a second day of a general strike which will see thousands take to the streets.

We know that the troika has advised that another 30 billion euros needs to be found to keep Greece afloat. We also know that the IMF has been pressing for the ECB and euro zone governments to take a writedown on Greek bonds they hold, which Germany refuses to do so (which means it won’t happen, for now at least). The Eurogroup is awaiting the troika’s final report and it’s looking less likely that a definitive plan will be signed off at next Monday’s meeting of euro zone finance ministers.

Nonetheless, it’s in no one’s interests to let Greece crash at this point so the presumption is a deal will be done, probably featuring Greece getting two extra years to make the cuts demanded of it, extending maturities on its loans and cutting the interest rates. Talk of the ECB foregoing profits on the Greek bonds it holds (rather than taking a loss, since it bought them at a steep discount) continues to do the rounds. A further German condition is for a ring-fenced escrow account to hold some Greek tax revenues to ensure that it services its loans. Greece will probably also be allowed to issue more t-bills to tide it over though that requires the ECB’s acquiescence since Greek banks are entirely dependent on central bank liquidity and have been offering those t-bills up as collateral. Mario Draghi is speaking today.

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.

Greek tragedy turns epic

The Greek standoff continues. The Democratic Left, a junior party in the government’s coalition, could not be swayed and said it would vote against labour reforms demanded by the EU and IMF, so a deal putting Greece’s bailout terms back on track remains elusive.

Just as worryingly, Reuters secured an advance glimpse of the EU/IMF/ECB troika’s report on Greece which showed the debt target of 120 percent of GDP in 2020 will be missed (surprise, surprise) and as things stand will come in at around 136 percent. In other words, more money – up to 30 billion euros –  is going to be needed be that via lower interest rates and longer maturities on loans and/or a writedown on Greek bonds held by the European Central Bank and euro zone governments.

We know the IMF is very keen on the latter, believing that is the only way the numbers can be made to add up. We also know that Germany and others are just as resistant. Other schemes, such as Athens using privatization proceeds to buy back bonds, which has inbuilt leverage since it can do so at a quarter of their face value, may yet come into the mix but don’t alone look like they’ll make enough of a dent in Greece’s debt mountain. Athens looks set to get the extra two years it requested to make the cuts demanded of it, which also falls into the “necessary but insufficient” category.

Enter the dragon

Big day in Berlin with European Central Bank chief Mario Draghi entering the lion’s den of the Bundestag to explain to German lawmakers why his plan to buy sovereign euro zone bonds in potentially unlimited amounts poses no threat to the ECB’s remit and the euro zone economy.
Former ECB chief economist Juergen Stark – one of Draghi’s most trenchant critics – told us yesterday that the ECB president must present much more convincing arguments than hitherto as to why the plan would not pile enormous risks onto the ECB’s balance sheet for which European taxpayers could have to pay.

The session, which will include 10-minute introductory remarks from Draghi followed by a lengthy Q&A and then short public statements from Draghi and Bundestag President Norbert Lammert, is a rarity. The hawks in parliament will demand to know how bond-buying is remotely in line with the ECB’s mandate. The more moderate will at least want to hear what sort of conditionality the ECB wants to see before it leaps into the breach, and the backdrop is coloured by continued Bundesbank opposition to the Draghi strategy. Angela Merkel is speaking at a separate event in Berlin in, as does Wolfgang Schaeuble later in the day.

Spain will probably loom largest for the German lawmakers but Greece continues to run it a close second with suggestions growing that it will get an extra two years to make the cuts demanded of it. But even that may not be enough for the EU/IMF/ECB troika of inspectors to conclude that Athens’ debt sustainability programme is back on track. The IMF appears to believe that only a writedown of Greek bonds held by the ECB and euro zone governments will do the trick. They, predictably, are not keen.

Spanish waiting game

Spanish Prime Minister Mariano Rajoy secured an overall majority in regional elections in Galicia over the weekend but in the Basque country, the nationalists were the big winners. These polls have been identified as one reason why Rajoy has held off asking for sovereign aid and Catalan elections still loom next month. Rajoy is likely to have to offer politically poisonous pension reforms in return for outside assistance.

So far, we seem to be no closer to a bailout request, which could then trigger European Central Bank intervention, and with 10-year yields having dropped more than two percentage points from a 7.5 percent peak since Mario Draghi’s vow to do whatever it takes to save the euro, one could reasonably ask why Madrid should be in a hurry. Some officials are saying Spain could quite comfortably wait until the turn of the year, leaving a prolonged period of limbo.

The fact is that if market pressure comes back on, Spain can quickly approach the euro zone’s ESM rescue fund for help and the ECB can pile in thereafter. So what has happened is that a bit of fear has been put back into investors intent on shorting the euro zone periphery to their hearts’ content; fear that wasn’t there until recently. It looks increasingly likely that Madrid would seek a precautionary credit line from the ESM, with conditions attached, which in theory could allow the ECB to buy Spanish bonds without the government actually taking money from the rescue fund. That would be a much easier sell politically.