MacroScope

A Rubicon crossed

What a weekend. The euro zone crossed a dangerous Rubicon by whacking Cypriot bank depositors as part of a bailout – a dramatic departure from previous aid programmes. The finance ministers insist it is a one-off (as they did for Greece) but if investors and bank customers fear a precedent has been set, there could yet be a serious backwash for the euro zone. And all this for six billion euros? It seems perplexing to say the least although our trawl of the streets of the euro zone periphery has detected little alarm so far.

Markets are voting with their feet. The euro has dropped well over one percent, European stock futures are pointing to losses of two to three percent and the safe haven Bund future has leapt a full point at the open. Italian bond futures have done the reverse, suggesting that in the bond market at least, there is more than a little concern about contagion from Cyprus. “The crisis is back,” one bond trader told us. “Precedent” is the word on everybody’s lips. I’ve used it before but Bank of England Governor Mervyn King produced the definitive line on bank runs – it’s never logical to start one but it sure could be logical to join one.

To muddy the waters further, the Cypriots are trying to renegotiate the deal to ease the 6.5 percent burden on smaller depositors and raise it on the richer (from 9.9 percent). This suggests that the president fears that today’s parliamentary vote may be lost without changes. If it is lost – no party has a majority and three of them said yesterday they wouldn’t support the programme – we’re in for a real rollercoaster as everyone scrambles to avoid a default, with all the reputational damage that will do to the euro zone. At that point, we could probably kiss goodbye to the five months of calm imposed by the European Central Bank and its “do whatever it takes” pledge.

On the other hand, if it is passed, this could blow over. Cyprus is a special case with a banking sector – home to money laundering – dwarfing the size of the economy, and the size of the bailout had to be trimmed to something plausible somehow. That may have been the price of keeping the IMF on board, something which the Bundestag probably requires to support this. So better communication by the eurocrats could get that across. Either way, the IMF’s call on Friday for the currency area to press ahead with a common deposit guarantee – a red line for Germany – looks startlingly prescient.

A source close to the consultations told Reuters Nicosia is hoping to cut the tax band to 3.0 percent for deposits under 100,000 euros. Brussels said last night that would be fine as long as the net savings were the same. President Anastasiades is also trying to sugar the pill by offering savers who lost money shares in commercial banks, with equity returns guaranteed by future revenues expected from natural gas discoveries. Another potential spanner in the works has come from Russia (a lot of the deposits in Cyprus are Russian-owned) which says it still hasn’t decided whether to roll over its existing $2.5 billion loan to Cyprus at more favourable rates – something the euro zone is counting on.

Euro zone triptych

Three big events today which will tell us a lot about the euro zone and its struggle to pull out of economic malaise despite the European Central Bank having removed break-up risk from the table.

1. The European Commission will issue fresh economic forecasts which will presumably illuminate the lack of any sign of recovery outside Germany. Just as starkly, they will show how far off-track the likes of Spain, France and Portugal are from meeting their deficit targets this year. All three have, explicitly or implicitly, admitted as much and expect Brussels to give them more leeway. That looks inevitable (though not until April) but it would be interesting to hear the German view. We’ve already had Slovakia, Austria and Finland crying foul about France getting cut some slack. El Pais claims to have seen the Commission figures and says Spain’s deficit will will come in at 6.7 percent of GDP this year, way above a goal of 4.5 percent. The deficit will stay high at 7.2 percent in 2014, the point so far at which Madrid is supposed to reach the EU ceiling of three percent.

2. Banks get their first chance to repay early some of the second chunk of more than a trillion euros of ultra-cheap three-year money the ECB doled out last year. First time around about 140 billion was repaid, more than expected, indicating that at least parts of the euro zone banking system was returning to health. Another hefty 130 billion euros is forecast for Friday. That throws up some interesting implications. First there is a two-tier banking system in the currency bloc again with banks in the periphery still shut out. Secondly, it means the ECB’s balance sheet is tightening while those of the Federal Reserve and Bank of Japan continue to balloon thanks to furious money printing. The ECB insists there is plenty of excess liquidity left to stop money market rates rising much and a big rise in corporate euro-denominated bond sales helps too. But all else being equal, that should propel the euro yet higher, the last thing a struggling euro zone economy needs.

Currency chatter

With the rhetoric getting more heated, the three-year market fixation on bond yields could well be supplanted by currencies in the months ahead.

This week, everything points towards the first meeting this year of G20 finance ministers and central bankers in Moscow on Friday and Saturday. We’ve already got a clear steer from sources that even though France wants the strong euro on the agenda there will be little pressure put on Japan and others whose policies are pushing their currencies lower. Having urged Tokyo to reflate its economy last year, its G20 peers can hardly complain now that it has. That is not to say there won’t be lots of words on the issue though.

The Wall Street Journal has a piece saying the G7 – or at least its European and U.S. constituents – are planning a joint message ahead of the G20 to warn against a destabilizing competitive currency devaluation race. If true, this will have a big impact on the FX market.

Super, or not so super, Thursday

For those who thought the euro zone had lost the power to liven things up, today should make you think again.

ITEM 1. The European Central Bank meeting and Mario Draghi’s hour-long press conference to follow. Rarely has a meeting which will deliver no monetary policy change been so pregnant with possibilities.

Draghi, the man tasked with becoming the European bank regulator on top of all his other tasks, will face some searing questioning on his time as Bank of Italy chief and what he knew about the disaster that has befallen the country’s oldest bank, Monte dei Paschi.

Market/economy disconnect?

Italy comes to the market with a five- and 10-year bond auction today and, continuing the early year theme, yields are expected to fall with demand healthy. It could raise up to 6.5 billion euros. A sale of six-month paper on Tuesday was snapped up at a yield of just 0.73 percent. Not only is the bond market unfazed by next month’s Italian elections, which could yet produce a chaotic aftermath, neither is it bothered by the scandal enveloping the world’s oldest bank, Monte dei Paschi, which is deepening by the day.

Even before this week (it also sold nearly 7 billion euros of debt on Monday), Italy had already shifted 10 percent of its annual funding needs. Clearly it, and Spain, is off to a flying start which removes a lot of potential market pressure.

But the disconnect with the miserable state of the two countries’ economies should still give pause for thought. Flash Q4 Spanish GDP figures, out later, are forecast to show its economy contracted by a further 0.6 percent in the last three months of the year, with absolutely no end to recession in sight. That looks like a good opportunity to detail the state of the Spanish economy and how it could yet push Madrid towards seeking outside help. Italian business confidence data are also due.

Don Rajoy de la Mancha: Spain’s “quixotic” adventures

 

Spain will not seek aid imminently, says Prime Minister Mariano Rajoy. And by imminently, he means, not this weekend. Just the latest twist in a European crisis plot that now sees Spain as its primary actor.

The focus on Spain’s reluctance to see foreign aid, a pre-condition for additional European Central Bank purchases of its bonds, is ironic given the country’s record of goading weaker counterparts into similar rescue packages earlier in the crisis.

To Lena Komileva, chief economist at G+ Economics, the saga is all too reminiscent of the hapless meanderings of Don Quixote. Komileva argues that the country’s latest budget announcement marks only the beginning of a deeper, almost circular plight:

Spanish rescue could cause collateral damage for Italy

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Mounting speculation that Spain is prepping for a bailout begs the question – what happens to Italy?

Sources told Reuters Spain is considering freezing pensions and speeding up a planned rise in the retirement age as it races to cut spending and meet conditions of an expected international sovereign aid package.

Markets took this to mean it was preparing the ground for eventually asking for help. According to Lyn Graham-Taylor, fixed income strategist at Rabobank:

Spanish yield curve flattens, along with Europe’s fortunes

Ten-year Spanish government bond yields hit their highest levels since the euro was created – above 7 percent – on growing doubts that the euro zone’s fourth largest economy will be able to avoid a full-blown sovereign bailout.

News that Spain’s heavily indebted eastern region of Valencia would ask Madrid for financial help reinforced concerns the country may eventually run out of funds. The rubber-stamping of a rescue package for Spain’s troubled banking sector did little to allay concerns.

Short-dated bonds came under particular pressure, flattening the Spanish yield curve further in a sign of mounting credit worries. Five-year bond yields hit a euro-era high of 6.928 percent, flirting with the widely dreaded 7 percent mark.

Breaking up is hard to do – even for stoic Germany

German Bund futures have just had their second straight week of losses. This has left many scratching their heads given the timing – right before Greek elections that could decide the country’s future in the euro and the next phase of the euro zone debt crisis. That sort of uncertainty would normally bolster bunds, which are seen as a safe-haven because of the country’s economic strength.

To explain the move, analysts pointed to profit-taking on recent hefty gains, and to a bout of long-dated supply from highly-rated Austria, the Netherlands and the European Financial Stability Fund this week. They also noted changes in Danish pension fund rules as an additional technical factor reducing demand for longer-dated German debt.

The losses, however, have also prompted some debate about whether contagion is spreading to Germany, the euro zone’s largest economy.

Spanish bailout blues

100 billion used to be a big number. These days, it barely buys you a little time.

Euro zone finance ministers agreed on Saturday to lend Spain up to 100 billion euros ($125 billion) to shore up its ailing banks and Madrid said it would specify precisely how much it needs once independent audits report in just over a week. 

A bailout for Spain’s banks, struggling with bad debts since a property bubble burst, would make it the fourth country to seek assistance since the region’s debt crisis began, after Greece, Ireland and Portugal.