MacroScope

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.

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.

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.

Like over-hyped Olympian, Fed set to disappoint

Pity the Federal Reserve. Like an over-hyped Olympian, the U.S. central bank enters this week’s policy meeting with sky-high expectations and a high probability of disappointment.

Markets are salivating at the prospect of a decisive easing move when Fed policymakers emerge from their meeting on Wednesday. The S&P 500 is up 3.6 percent in the last four sessions as traders hold out hope the Fed will launch a third round of quantitative easing, or QE3, to blast the U.S. economy out of its funk. Stumbling job creation, manufacturing and spending, as well as a measly 1.5 percent GDP growth in the second quarter and serious spillover threats ahead from Europe’s debt crisis, all feed this thesis. Fed policymakers from Chairman Ben Bernanke on down the line to Cleveland Fed President Sandra Pianalto and James Bullard of St. Louis have also stoked the market with a more dovish tone the last little while. And yet, this is probably not the time for a big policy move.

Topping the list of reasons to disappoint – and to knock the market down to size – the Fed probably doesn’t want to front-run the July employment report that’s due on Friday, and which will give a fresh sense whether the spring-summer slump in the labor market is temporary or more permanent. Waiting until the Fed’s next scheduled meeting, Sept. 12-13, would give policymakers the added benefit of the August jobs report. And speaking of front-running, the U.S. central bank may not want to get out just ahead of the European Central Bank’s policy decision on Thursday. If, down the line, things get really ugly in Europe – or if the U.S. Congress sends the country off the so-called fiscal cliff – the Fed will probably want to have the QE3 bazooka ready in its arsenal.

Euro zone facing autumn crunch?

Spain remains the focus for the markets but here comes Greece racing up on the outside lane. Officials told us exclusively yesterday that Athens is way, way off the targets set by its bailout programme and a further restructuring will be needed. If so, it’s almost inevitable this time that euro zone governments and the ECB will have to take a hit. Are they prepared to? There’s little sign of it so far although a key ally of German Chancellor Angela Merkel said last night that a second haircut was an option.

CDU budget expert Norbert Barthle said Greece would do its level best to stay in the euro zone, and given the losses associated with its departure and the fact that it could also prove a tipping point for Spain, there are powerful reasons to hope that’s true. But, but, but it’s pretty apparent that Athens has little chance of delivering the cuts being asked of it without completely wrecking its economy even if it is cut a bit more slack. And the latter is a big “if” too. It’s hard to see Merkel telling the German public they are going to face another bill to keep Greece afloat. As Barthle said, a second debt write off “would cost us a lot of money”. He also flagged up another problem that has been aired in recent days – that the IMF would probably not stump up any more funds given Greece has not met its stipulations.

The euro zone has indicated it will keep Greece afloat through August while the troika of EU/IMF/ECB inspectors assess the situation but we could be approaching a crunch point in September or October and if we get there the big “contagion” question is back – would a full Greek default or euro zone exit (and by the way some policymakers have floated the possibility of allowing Greece to default within the euro zone because it would be slightly less chaotic) lead to a collapse of confidence in Spain?

A summer lull?

It seems foolish to hope for a summer lull given recent history but in euro zone debt crisis terms at least, the next week looks quieter unless the markets turn savage again.

That’s not to say things are getting better – Spain’s 10-year borrowing costs are still above the seven percent level which it cannot survive indefinitely — it’s just that things aren’t getting much worse at the moment. Certainly with the Spanish bank bailout signed off as far as it can be, there’s nothing on the policy front to shake things up for a while although the debt-laden region of Valencia’s call for help with its debt hardly inspires confidence that Madrid can get things back on track.

What there is next week is a welter of evidence coming up on the health, or lack of it, of the world economy.
Flash PMIs for the euro zone, France and Germany are swiftly followed by Germany’s Ifo sentiment survey and second quarter GDP figures from Britain. The Q2 U.S. growth figure also comes out on Wednesday as well as the Chinese PMI on Tuesday. The euro zone’s slide into recession is likely to be confirmed and of course Britain is already there and unlikely to clamber out despite government and central bank protestations that the country’s travails are all to do with the euro area.