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.
Europe’s economy stagnated in the first quarter of 2012 and is expected to shrink 0.4 percent this year, according to another recent Reuters poll. Data on Thursday certainly pointed in that direction, suggesting even wealthier countries like France and Germany are also starting to feel the pinch.
Greek political poll tracker
Greece faces another election on June 17. Although they reject the austerity required by the bailout, most Greeks want their country to stay in the euro. However Frankfurt and Brussels say it is impossible for Greece to have one without the other: no bailout means no euro and a return to the drachma. Whether the Greek people believe these warnings could have a big impact on the election result.
First place comes with an automatic bonus of 50 seats, meaning even the slightest edge could be pivotal in determining the makeup of the next government.
Click here for an interactive chart showing the latest polls:
The party is clicked by default in the interactive version. The absence from the “photo” on the blog was an oversight, which has now been corrected. Thank you for pointing this out.
Risk of contagion if Greece exits euro: WestLB
What happens if Greece leaves the euro? No one can say for sure. But John Davies at WestLB, finds it difficult to envision a benign outcome.
Greece’s economy, at around $300 billion, is very small compared to the euro zone as a whole. The problem is if other countries follow suit – or are pressured in that direction by stubborn financial markets.
Such a scenario doesn’t bear thinking about because it is so horrible.
There is a good chance that the market would immediately trade Portugal towards pre-debt swap Greece levels. The next in line would certainly be Ireland and Spain.
Initially you have got to assume that spreads would become even more dislocated. As you are moving out and down the credit curve the ones with the weakest credit ratings will likely suffer worst, at least initially, because we are moving clearly into the world of the unknown and that’s precisely what the market doesn’t like.
The Greek elections have left a political vacuum that is raising speculation that the country may eventually exit the euro. Last Sunday, Greek voters punished mainstream parties that supported harsh austerity in exchange for international bailout cash. That left the Greek parliament with a jumble of minority parties that have been unable to form a government.
The leaders of Greece’s once-dominant conservative and socialist parties made a push on Friday to avert new elections and prevent a victory by a radical leftist who has promised to tear up its international bailout deal.
Inability to implement the reforms set out by international lenders amid this political void could compromise the country’s life-support bailout money and lead to a default. This could make the country’s membership of the euro increasingly unsustainable, even though those very reforms risked choking growth further in an economy suffering its fifth year of recession.
Even Germany, the key driver of growth in the euro zone, might eventually be threatened by worsening financial and economic conditions around it. And what of the bullish German Bund market which seems to know no bounds? Davies again:
debt relief by more debt added faster…faster..faster.faster…
the math is compelling.
the greeks must default…default..default.default…
printing is the world’s only current option. if, and only if, the major currencies agree to unified manipulation of currencies, and stick to it, can the pain inflicted by fiat foolishness be gentled enough to allow the real people to be ok.
p.s. the printers must agree to a fixed ‘flow’, but that’s another story.
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.
Peter Allwright of investment management firm RWC Partners goes one step further. He can envision a scenario where the German Schatz trades at significantly negative yields as the crisis unfolds.
There is going to be a huge shortage of triple A collateral in euros and if people start to price in the euro break-up scenario, people are going to be pushed into that.
“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.
The premium investors require to hold French debt over German Bunds has also risen in the run-up to the French vote as Francois Hollande became the favourite to win.
But as economies fall deeper into recession and double-digit unemployment hurts prospects for growth, the view that austerity alone will not solve the euro zone debt crisis, seems to be gradually winning over some investors in the bond market – the heart of the crisis.
Sanjay Joshi, head of fixed income at London and Capital, says:
Europe in recession – an interactive map
Spain has become the latest European country to slip into recession joining the Belgium, Cyprus, The Czech Republic, Denmark, Greece, Italy, The Netherlands, Ireland, Portugal, Slovenia and the United Kingdom.
Click here to view an interactive map.
*Updated to include Romania and Bulgaria
Thanks for comments – Will update with Romania and Bulgaria
Spanish banks 1, Spanish mortgages 0
The trillion euros lent out by the European Central Bank for three years at a rock bottom interest rates were supposed to do two things – throw a comfort blanket around Europe’s wobbly banks and pump money into moribund economies. Some new data from struggling Spain confirms that while there may be a bit of a case for the former, the latter is still falling short.
Mortgage lending by Spanish banks had their largest annual drop in more than six years in February – coming in at essentially half of what they were a year earlier. There are all kinds of reasons for this, not the least being that large numbers of Spaniards are out of work and house prices are still tumbling with at least one estimate being that they remain as much as 30 percent overvalued.
But given that Spanish lenders were among the biggest taker of the ECB’s largesse (officially known as LTROs, a name only a central banker’s mother could love) the lack of trickle down is less than bracing. The suspicion is that Spain’s banks are holding back on lending because of their wonky balance sheets, which is of course a good thing in itself it it keeps the financial system on its feet.
This would fit with data from the ECB itself showing banks in general are so flush with money they don’t know what to do with it. Tuesday’s ECB’s overnight deposit facility showed banks parking 768 billion euros there. In normal times the amounts are minimal.
So while the money may be helping bank’s rebuild their balance sheets (Goal 1), it is not yet getting into the general economy (Goal 0).
Just ask a Spanish home buyer.
Netherlands at core of the crisis
The Netherlands has become the latest country to come into the firing line of the euro zone crisis.
The cost of insuring five-year Dutch debt against default jumped to its highest since January as the government’s failure to agree on budget cuts spiraled into a political crisis and cast doubt over its support for future euro zone measures.
Dutch Prime Minister Mark Rutte offered to resign on Monday, creating a political vacuum in a country which strongly backed an EU fiscal treaty.
Five-year Dutch CDS jumped 14 basis points to 133, only a whisker away from the record of 136 basis points hit on November of last year. The premium that investors require to hold 10-year Dutch bonds over their equivalent German Bunds rose to 79 basis points – its highest in 3-years.
Commerzbank’s take on Holland:
Elections could be held in September 2012 at the earliest, because the Dutch constitution prescribes a period of 80 days between the dissolution of the government and new elections. In the interim, the government would be unable to get important reforms approved by parliament. This suggests that the 3 pct (budget deficit) target will be missed in 2013 and the country’s AAA rating is at risk.
A Dutch debt auction on Tuesday will provide another test of investor appetite following Monday’s selloff.
It began with countries of Asia, Africa and Latin America, now IMF is striking Europe and it seems that Europe either is still asleep or there is a rat. Iceland, Greece, Italy, Spain, Portugal and now Holland…people of Europe .. we need to wake up, and show solidarity to countries like the above, because, as you can probably see on your own, you are the next victim of this unsatisfied moneythirsty organization and this canserlike system.Capitalism is out of control, we need to act fast…please…
Never mind the pain, feel the austerity
Austerity in the euro zone seems to be working — at least as far as the headline, dry, soulless numbers of budget balancing are concerned. Bailed out Greece and Ireland have reported substantial improvements in last year’s profligacy performance. Spain, while going in the wrong direction, at least has the satisfaction of being told it is not telling fibs.
We will get to the smoke and mirrors in a bit.
First Greece, the euro zone’s poster child for budget ill-discipline. The 2011 budget deficit to GDP ratio – basically the annual overspend — came in at 9.1 percent. This may seem like a lot given the EU target is 3 percent, but it was down from 10.3 percent a year earlier and from 15.6 percent the year before that. Furthermore, if you take out all the debt repayments costs that Athens has to make , you end up with only 2.4 percent (although in truth that is like pretending you don’t have a mortgage).
In Ireland, the craic was all about trouncing expectations. The deficit to GDP ratio for 2011 came in at 9.4 percent, which compared with an original 10.6 percent target and even a revised target just last December of 10. 1 percent. Everything is on track, Dublin reckons, to meet this year’s 8.6 percent.
Now, those not wanting their party pooped, please look away.
The official figures suggest that Greece’s improvement is almost entirely down to increased revenues. Government spending as a percentage of GDP last year was 50.1 percent, barely changed from a year early and only a tad down from 2008. And this comes after a number of years of painful austerity that has helped keep Greece in recession for more than four years — it is into its fifth now, staring at a 4.8 percent 2012 contraction — and that has pushed more than a fifth of the country out of work. Greece’s debt (ie accumulated deficits) as a proportion of GDP last year was 42.3 percentage points higher than in 2008.
Ireland, in the meantime, was enjoying its deficit improvement (still the worst in the euro zone) by finessing away one-off capitalisations into its banks that were worth some 3.7 percent of GDP. Including those and some others, the deficit last year was 13.1 percent. This comes after Ireland has made budgetary adjustments totalling 25.4 billion euros since 2008 — the equivalent to 16 percent of it 2011 GDP — and has had to hike taxes and cut spending by 8.6 billion euros between 2013 and 2015, i.e. another 5 percent of GDP. It is back in recession and seeing its exports hit by the troubles is main trading partners in the European Union are having.
Eurobonds key to financial stability: Nobel economist
There’s no other way. In order for Europe to hold together as a monetary union it must be able to issue a currency region-wide bond. That’s according to Christopher Sims, Nobel-prize winning economist and Princeton University professor, speaking on a panel at the IMF over the weekend:
My view is that the only way to preserve the usual manner of operation of monetary policy in Europe, and the usual operation of financial institutions is to deliver on the Eurobond, and not after years but soon. A Eurobond that could be used as the main instrument of monetary policy in Europe would go a long way to stabilizing the financial system.
This explains why Europe is in trouble while other industrialized nations that also face high debt levels are not seeing anywhere near the same market pressures, Sims said:
There is a very important distinction between inflation risk and default risk. There is a kind of a default premium. An entity that issues debt that only promises to pay paper that it can print for free, is free of any risk that the entity will be unable to deliver on the contract terms. It’s one thing for markets to worry about unpredictable inflation reducing the value of a bond. Another thing is for the markets to be uncertain whether at the next rollover this issue of debt is going to not be fully paid or whether there might be a general haircut on debt.
The risks to holders of debt of an unspecified form of default is much more disruptive than the risk of losing some of the value of the debt through unpredictable inflation. And I think that’s why even though on fundamentals the UK and the U.S. and Japan look like they’re in as much trouble as European countries, nonetheless those countries can print what they promised to pay. So there’s no short-term risk of a sudden, unpredictable allocation of losses across different bondholders.
It makes sense. Yet given the complicated political challenges posed by the issuance of a common bond across separate nations, Europe better hope Sims has it wrong.
