MacroScope

Europe’s reactive leadership

Spain doesn’t need financial help. That was the verdict from euro zone ministers on Monday – quickly followed by a selloff in Spanish stocks and bonds on Tuesday. The trouble with that line of thinking is that it again leaves policymakers behind the curve, reacting to events rather than preempting them, write currency strategists at Brown Brothers Harriman in a research note:

For several weeks now Germany Finance Minister Schaeuble has argued against the need for Spain to request aid. France and Italy, in contrast, have been reportedly encouraging Spain to ask for assistance, which they assume would ease financial pressures within the region as whole. The Eurogroup meeting of euro area finance ministers endorsed Schaeuble’s position. Spain is taking necessary measures to overhaul the economy, they said.  Spain is able to successfully fund itself in the capital markets. Aid is simply not needed now.

While there is a compelling logic to the argument, the problem is that it prevents officials from being proactive rather than continue to its reactive function. It means that whenSpaineventually requests assistance, it will be in a crisis and the cost of assistance will be greater. It is penny-wise but dollar foolish. By failing to find a preventative salve, officials are not maximizing the breathing space that the ECB has created (intentionally or otherwise).

Spanish bonds on the block

Having done so with a t-bill sale on Tuesday, Spain will continue to try and cash in on the relatively benign market conditions created by the European Central Bank by selling up to 4.5 billion euros of 3- and 10-year bonds. It hasn’t tried to sell that much in one go since early March, when the ECB’s previous gambit – the three-year liquidity flood – had also imposed some calm upon the markets, albeit temporarily (there’s a lesson to be learned there).

Yields are likely to fall sharply from the most recent equivalent auctions but even so, it looks unlikely that Madrid can meet some daunting looking refinancing bills before the year is out, without outside help. Prime Minister Mariano Rajoy’s hesitation about making a request for bond-buying help from the ESM rescue fund, with the ECB rowing in behind, has already pushed Spanish 10-year yields back up towards six percent after a more than two-point plunge since ECB chief Mario Draghi issued his “I’ll save the euro” proclamation in late July.  They had peaked around 7.5 percent before that.

With the ECB having pledged to buy bonds if necessary, but only at the shorter end of the maturity scale, the three-year bonds should be snapped up. The 10-year issue may be a harder sell. The danger is that Spain (and Germany, which is saying Madrid shouldn’t take a bailout unless market pressure returns with a vengeance) dithers for so long that the positive sentiment created by Draghi dissipates completely.

No time for complacency

After a tumultuous fortnight where the European Central Bank, U.S. Federal Reserve, German judges and Dutch voters combined to markedly lift the mood on financial markets, we’re probably in for a more humdrum few days, although a raft of economic data this week will be important – a critical mass of analysts are saying that after strong rallies, it will require evidence of real economic recovery, rather than crisis-fighting solutions, to keep stocks heading up into the year-end.

A weekend meeting of EU finance ministers reflected the progress made, but also the remaining potential pitfalls. Our team there reported the atmosphere was notably more relaxed and Spain’s announcement that it would unveil fresh economic reforms alongside its 2013 budget at the end of the month sent a strong signal that a request for bond-buying help from Madrid is likely in October. If made, the ECB could then pile into the secondary market to buy Spanish debt  if required and hopefully drag Italian borrowing costs down in tandem with Spain’s.

BUT. The Nicosia meeting also exposed unresolved differences between Germany and others over plans to build a banking union. German Finance Minister Wolfgang Schaeuble said handing bank oversight to the European Central Bank is not in itself sufficient to allow the euro zone’s rescue fund to directly assist banks – another key plank of the euro zone’s arsenal. It sounds like that debate went nowhere.
Having largely been the dog that hasn’t barked so far, public unrest is on the rise with big marches in Portugal and Spain over the weekend against further planned tax hikes and spending cuts.

Do they they think it’s all over?

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.

Get me to the court on time

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.

Another euro zone week to reckon with

Despite Mario Draghi’s game changer, or potential game changer, the coming week’s events still have the power to shape the path of the euro zone debt crisis in a quite decisive way, regardless of the European Central Bank’s offer to buy as many government bonds as needed to buy politicians time to do their work.

The nuclear event would be the German constitutional court ruling on Wednesday that the bloc’s new ESM rescue fund should not come into being, which would leave the ECB’s plans in tatters since its intervention requires a country to seek help from the rescue funds first and the ESM’s predecessor, the EFSF, looks distinctly threadbare. That is unlikely to happen given the court’s previous history but it could well add conditions demanding greater German parliamentary scrutiny and even a future referendum on deeper European integration. For the time being though, the markets are likely to take a binary view. ‘Yes’ to the ESM good, ‘No’ very bad.

Dutch elections on the same day look to have been robbed of some of their potential drama with the firebrand hard-left socialists now slipping in the polls and the fiscally conservative Liberals neck-and-neck with the likeminded centre-left Labour party. But there are no guarantees and Germany could yet be robbed of one of its staunchest allies in the debt crisis debate.

Biggest analyst split on ECB rate decision since euro launch

Some say the European Central Bank will cut rates. Some say they won’t.

The odds that either prediction could turn out to be true on Thursday are more even than since Reuters first began polling on ECB rates in 1999.

Even during the highly volatile, uncertain time that followed the collapse of Lehman Brothers, Reuters polls of ECB watchers always resulted in a clear majority of economists leaning toward one particular rate cut size.

In the Reuters poll taken last week, 36 of 70 economists expected the ECB to leave the refi rate at 0.75 percent, while almost as many, 34, said it would cut it to 0.50 percent.

Does the European crisis need to get worse to get better?

Europe will do what it takes to save the euro, after it tries everything else. That seems to be the conventional wisdom about the continent’s muddled handling of a financial crisis now well into its third year.

The latest whipsaw came this week when, having hinted at aggressive action on the part of the European Central Bank, its president, Mario Draghi, backtracked a bit by saying the ECB “may” take further non-standard measures such as purchases of government bonds of countries like Spain and Italy, which have come under extreme market pressure.

John Praveen, chief investment strategist at Prudential International Investments Advisers, notes Draghi appears to have attached a new condition to ECB bond buys. Those countries must first ask for a formal bailout from the European Union, which they are reluctant to do because of the tough austerity measures that would then be imposed on them.

Goldman thinks market’s disappointment with ECB is premature

Financial markets on Thursday were starkly disappointed with the European Central Bank and its president, Mario Draghi. He had promised recently to do everything in his power to save the euro and yet announced no new bond-buying at the central bank’s latest meeting. Riskier assets sold off and safe-haven securities benefitted.

But Francesco Garzarelli of Goldman Sachs, Draghi’s former employer, has a different take on the matter:

We see a material change in the central bank’s approach to the crisis, and a coherent interplay between fiscal and monetary policy. The underwhelming part of today’s announcements lies in the lack of details on the asset purchases and other measures to support the private sector. But it appears that these will have more structure around them than the SMP (Securities Markets Program).

U.S. bond bulls ready to charge after payrolls report, survey says

(Corrects to show CRT is not a primary dealer)

Bond bulls are ready to charge after Friday’s July U.S. employment data, according to a survey by Ian Lyngen, senior government bond strategist at primary dealer CRT Capital Group.

Says Lyngen:

Despite the vacation season and the multitude of ‘out of office’ responses we got, participation in this month’s survey was above-average and consistent with a market that’s engaged for the big policy/data events of the summer. As for the results of the survey, in a word: BULLISH.

Lyngen argued the survey results were the most bullish since November 2010, a point that was followed by a selloff that brought 10-year yields from 2.55 percent to 3.75 percent over the following four months.