MacroScope

A recovery in Europe? Really?

There’s a sense of relief among European policymakers that the worst of the euro zone’s crisis appears to have passed. Olli Rehn, the EU’s top economic officials, talked this week of a “turning of the tide in the coming months”. Mario Draghi, the president of the European Central Bank, speaks of “sizeable progress” and “a reassuring picture”.

At last week’s spring summit, EU leaders couldn’t say it enough: “This meeting is not a crisis meeting … it’s not crisis management,” according to Finnish Prime Minister Jyrki Katainen. All the talk is of how the euro zone’s economy will recover in the second half of this year.

But for the 330 million Europeans who make up the euro zone, the outlook has, if anything, darkened. As euro zone governments deepen their commitment to deficit-cutting, and rising oil prices mean higher-than-expected inflation, households can’t be counted on to drive growth. Not only did housing spending fall 0.4 percent in the October to December period from the third quarter, but unemployment rose to its highest since late 1997 in January.

Joblessness is reaching shameful levels in southern Europe. In Greece, unemployment rose to a new record high of 21 percent in December and to 23 percent in Spain in January. Even in wealthy, northern Europe, the number of people out of work has started to rise in France, the Netherlands and Germany.

Just over half of the euro zone‘s economic output is generated by domestic consumer spending, but demand for goods looks chronically weak and fiscal austerity is aggravating the situation. Euro zone governments, desperate to distinguish themselves from debt-stricken Greece, are completely unwilling to step in and spend. The European Commission, persuaded mainly by Germany that fiscal discipline will lift economic growth, is on their backs to get their deficits within the 3 percent level of GDP by the end of 2013.

Europe’s wobbly economy

Things are  looking a bit unsteady in the euro zone’s economy.  Just ask Olli Rehn, the EU’s top economic official, who warned this week of  “risky imbalances” in 12 of the European Union’s 27 members. And that’s doesn’t include Greece, which is too wobbly for words. 

Rehn is looking longer term, trying to prevent the next crisis. But the here-and-now is just as wobbly. The euro zone’s economy, which generates 16 percent of world output, shrunk at the end of 2011 and most economists expect the 17-nation currency area to wallow in recession this year and contract around 0.4 percent overall. Few would have been able to see it coming at the start of last year, when Europe’s factories were driving a recovery from the 2008-2009 Great Recession. And it shows just how poisonous the sovereign debt saga has become.

Not everyone thinks things are so shaky.  Unicredit’s chief euro zone economist, Marco Valli, is among the few who believe the euro zone will skirt a recession — defined by two consecutive quarters of contraction — in 2012. This year is “bound to witness a gradual but steady improvement in underlying growth momentum,” Valli said, saying the fourth quarter was the low point in the euro zone business cycle.

Risks from ECB debt drip

The abundance of European Central Bank liquidity in the euro zone financial system is making for smoother issuance of shorter-dated debt in the euro zone.

Case in point: Spain. This week the country sold double its previously announced target of three- and four-year government bonds amid solid demand.

But there are risks, particularly if the Treasuries of lower-rated countries get too comfortable issuing at the short-end of the curve. Michael Leister, strategist at DZ Bank, described the potential pitfalls in a telephone interview:

European rescue: Who benefits?

The words “European bailout” normally conjure up images of inefficient public sectors, bloated pensions, corrupt governments. But market analyst John Hussman, in a recent research note cited here by Barry Ritholtz, says the reality is a bit more complicated:

The attempt to rescue distressed European debt by imposing heavy austerity on European people is largely driven by the desire to rescue bank bondholders from losses. Had banks not taken on spectacular amounts of leverage (encouraged by a misguided regulatory environment that required zero capital to be held against sovereign debt), European budget imbalances would have bit far sooner, and would have provoked corrective action years ago.

In other words, even if state actors mishandled government finances, Wall Street was, at the very least, an all-too-willing enabler.

Money funds cut Europe exposure, slowly

Prime U.S. money funds further reduced their holdings of euro zone bank paper in December, although the pace of movement slowed while investors continued to hedge against any bank failures, J.P. Morgan Securities said on Wednesday.  The slower movement out of euro zone bank paper was the result of money funds having already strongly reduced their holdings, J.P. Morgan said in a note to clients.

Euro zone bank paper continued to roll off in December from prime money fund portfolios but has seen some slowing as nearly 70 percent of these exposures have been eliminated from prime fund portfolios over the course of the past year. In spite of continued reductions in euro zone bank exposures, prime fund assets under management were basically flat for the second consecutive month reflecting some level of investor comfort in the level of risk in price fund portfolios as much of the cash that left euro zone bank paper has been reinvested in non-European banks and other high-quality products.

The prime money funds had small net outflows of $2.6 billion in December after net inflows of $4 billion in November, according to J.P. Morgan.

Please take my money: The zero-yield bill

Wall Street firms are begging the U.S. Treasury to take their cash, at least judging by the latest auction of short-term Treasury bills. Treasury sold $30 billion of four-week bills at a “high rate” (pause for laugther) of 0.000% on Wednesday, a mix of strong demand for year-end portfolio shuffling but also a reflection of ongoing fears of a credit crunch emanating from Europe.

It was the fourth straight sale in as many weeks that brought a high rate of zero. The zero percent rate means buyers of the debt will receive no interest at all, sacrificing any return simply to hold cash in the safest of investments.

A rise in repo financing costs is “a sign the year-end demand for short, safe assets has begun,” said Roseanne Briggen, our New York-based colleage at IFR Markets, a unit of ThomsonReuters.

from Global Investing:

Hungary’s Orban and his central banker

"Will no one rid me of this turbulent central banker?"  Hungarian Prime Minister Viktor Orban may not have voiced this sentiment but since he took power last year he is likely to have thought it more than once.  Increasingly, the spat between Orban's government and central bank governor Andras Simor brings to memory the quarrel England's Henry II had with his Archbishop of Canterbury, Thomas Becket, over the rights and privileges of the Church almost 900 years ago. Simor stands accused of undermining economic growth by holding interest rates too high and resisting government demands for monetary stimulus.  The government's efforts to sideline Simor are viewed as infringing on the central bank's independence.

So far, attacks on Simor have ranged from alleging he has undisclosed overseas income to stripping him of his power to appoint some central bank board members. But  the government's latest plan could be the last straw -- proposed legislation that would effectively demote Simor or at least seriously dilute his influence. Simor says the government is trying to engineer a total takeover at the central bank.  "The new law brings the final elimination of the central bank's independence dangerously close," he said last week.  
 
The move is ill-timed however, coming exactly at a time when Hungary is trying to persuade the IMF and the European Union to give it billions of euros in aid. The lenders have expressed concern about the law and declined to proceed with the loan talks.  But the government says it will not bow to external pressure and plans to put the law to vote on Friday. That has sparked general indignation - Societe Generale analyst Benoit Anne calls the spat extremely damaging to investor confidence in Hungary. "I just hope the IMF will not let this go," he writes.

Central banks and governments often fail to see eye to eye. But in Hungary, the government's attacks on Simor, a respected figure in central banking and investment circles,  is hastening the downfall of the already fragile economy. For one, if IMF funds fail to come through, Hungary will need to find 4.7 billion euros next year just to repay maturing hard currency debt. That could be tough at a time when lots of borrowers -- developed and emerging -- will be competing for scarce funds.  Central European governments alone will be looking to raise 16 billion euros on bond markets, data from ING shows. So Orban will have to tone down his rhetoric if he is to avoid plunging his country into financial disaster.

Europe’s clear and present danger to U.S. economy

Jason Lange contributed to this post.

Suddenly the shoe is on the other foot. The financial crisis of 2007-2008 had its roots in the U.S. banking system and then spread to Europe. Now, it’s Europe’s political debacle that threatens economic growth in the United States.

A recent raft of better U.S. economic data, including a steep drop in weekly jobless claims reported on Thursday, have pointed to a swifter recovery. But such signals seem a bit futile when there’s a risk of another major global financial meltdown lurking.

Yet just what is the likely impact of the euro zone’s morass on the United States? Economists at Goldman Sachs ran some figures through their models, and the results were not pretty: overall, Europe’s crisis is likely to shave a full percentage point off U.S. economic growth.  In a world where economists have come to expect the “new normal” for U.S. growth to be around 2.5 percent, that could mean the difference between a decent recovery and one that is highly fragile and vulnerable to shocks.

What the euro crisis is not

With Southern Europe getting so much of the blame for the continent’s financial crisis, it is refreshing to see someone highlight the other side of the coin. That’s just what Joshua Rosner, managing director of Graham Fisher & Co., did in testimony on Thursday. Asked to discuss the potential risk to U.S. taxpayers of the ongoing political battle over a frayed monetary union, Fisher began his remarks by debunking the reigning narratives being used to describe the crisis:

To fully assess the risks to the United States and our proper role in the euro zone  crisis it must first be clear what the crisis is and is not. It is not a bailout of the populations of the weaker European economies such as Greece, Ireland, Portugal, Italy, Spain, Hungary or Belgium. After all, the populations of those countries are being forced to give up portions of their sovereignty in the name of austerity toward a fiscal union.

Rather, I would contend, it is a bailout of banks in the core countries of Europe, of their stockholders and creditors who, failing to gain sufficient access capital markets, would need to be recapitalized by their host country governments. It is a transfer of losses from banks and corporations onto the backs of ordinary people without requiring any recognition of losses by those banks whose risk management and lending practices created the problem. It is as much a tale of over lending as it is of over borrowing and, just as nobody should feel undue sympathy for those who miscalculated the amount of debt they could service, nobody should feel for those who miscalculated their lending risks.

Without “bazooka,” Europe still vulnerable

This time it was going to be different. A make-or-break, comprehensive, grand, “bazooka” solution would draw a line under the euro zone debt crisis.

But the plan agreed by all EU states except Britain to pursue stricter budget rules and a stronger fiscal union did little to soothe bond markets. Ten-year Italian yields rose as far as 6.8 percent, prompting the European Central Bank to intervene in the secondary market, and German Bunds rose more than 100 ticks on the day.

Among the short-falls, the capacity of the euro zone’s bailout fund was capped and it was not granted a banking license. For now, this puts more pressure on the European Central Bank to help contain the crisis by stepping up bond-purchases. The bank however has repeatedly resisted a bigger crisis-fighting role and last week dampened expectations that it could ramp up a program which has tried to keep borrowing costs affordable. The legal basis of a new accord to enforce debt and deficit rules also still needs to be worked out.