MacroScope

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.

Analysts at Societe Generale:

The outcome of the EU summit may be good enough to keep the holiday season from being spoiled by nasty market disruptions. But we fear that it is not the bazooka that can carry us to the wall of Q1 supply with much confidence.

The euro zone’s funding needs are estimated at more than 800 billion euros next year, and 215 billion euros for Italy alone.

The real facilitators of Europe’s crisis talks

“Sometimes it’s good to do these things in person,” U.S. Treasury Secretary Timothy Geithner said after meeting with German Finance Minister Wolfgang Schaeuble to discuss what to do about Europe’s debt crisis.

But it’s not easy pulling off a 72-hour, five-city blitz of European officials to proffer advice and some discreet prodding. It involves crossing the Atlantic Ocean twice and darting between Frankfurt, Berlin, Paris, Marseille and Milan, holding eight face-to-face meetings and three media sessions, as well as speaking with heads of state, finance ministers and central bankers.

Of course you need your own plane. Not a problem for the U.S. Treasury chief, who regularly has a blue-and-white military 737 at his disposal.

Contagion strikes Europe’s core

Any lingering illusion that the European crisis could be contained to so-called peripheral countries with high debt levels was shattered on Wednesday. German government bonds, which had thus far been seen as a safe-haven, slumped sharply after investors shunned the country’s auction of new 10-year debt.

Germany drew significantly less bids than the amount on offer for its Bunds, with investors deterred by very low yields. There is a growing view the euro zone powerhouse will pay a high price whatever the outcome of the regional debt crisis. If the crisis spirals out of control, some fear that it could reach a magnitude that would hit Germany as well by sending it into a deep recession. On the other hand, any solution to the crisis is likely to involve a higher fiscal bill for Germany.

Marc Ostwald at Monument Securities in London describe the auction as “a complete and utter disaster.” He continued:

The irrelevance of slightly better U.S. economic data

The latest round of reports on the U.S. economy, while hardly the ringing endorsement of a robust recovery, have been a bit better overall. Jobless claims, while still high, have fallen to a seven-month low of 388,000. Industrial output, meanwhile, posted its largest increase since July as factory and mining production expanded strongly.

But investors are far too obsessed with the mess taking place in Europe to pay the modest improvements any mind. Even if Europe’s financial morass were not an ongoing cloud over the U.S. outlook, the incremental gains in U.S. economic activity remain far too modest to warrant any sort of optimism about a substantial decline in unemployment. Moreover, analysts are worried that the current political propensity in Washington for spending cuts rather than renewed stimulus poses another threat to growth.

Thomas Lam at OSK-DMG sums up the sentiment nicely:

Incoming data over the past month or so have been generally more spunky. […] The continued tightening in financial markets and depressed sentiment indicators still imply downside risks to growth in subsequent quarters. But the key driver to the 2012 outlook, at least for the early part of next year, is fiscal policy considerations.

from Anooja Debnath:

When it comes to recessions, 40 is the new 50

If it were about age, 40-somethings would cringe. But it seems a dead certainty that 40 now means 50 -- or even higher -- when it comes to predicting the chances of a recession taking place.

Going by past Reuters polls of economists, every time the probability hits 40 percent, the recession's already started or is perilously close to doing so.

After the brief recovery period from the Great Recession, Reuters once again started surveying economists several months ago on the chances of developed economies stumbling back into the muck.

Contemplating Italian debt restructuring

This week’s evaporation of confidence in the euro zone’s biggest government debt market — Italy’s 1.6 trillion euros of bonds and bills and the world’s third biggest — has opened a Pandora’s Box that may now force  investors to consider the possibility of a mega sovereign debt default or writedown and, or maybe as a result of,  a euro zone collapse.

Given the dynamics and politics of the euro zone, this is a chicken-or-egg situation where it’s not clear which would necessarily come first. Greece has already shown it’s possible for a “voluntary” creditor writedown of  the country’s debts to the tune of 50 percent without — immediately at least — a euro exit. On the other hand, leaving the euro and absorbing a maxi devaluation of a newly-minted domestic currency would instantly render most country’s euro-denominated debts unpayable in full.

But if a mega government default is now a realistic risk, the numbers on the “ifs” and “buts” are being crunched.

from Global Investing:

Are global investors slow to move on euro break-up risk?

No longer an idle "what if" game, investors are actively debating the chance of a breakup of the euro as a creditor strike  in the zone's largest government bond market sends  Italian debt yields into the stratosphere -- or at least beyond the circa 7% levels where government funding is seen as sustainable over time.  Emergency funding for Italy, along the lines of bailouts for Greece, Ireland and Portugal over the past two years, may now be needed but no one's sure there's enough money available -- in large part due to Germany's refusal to contemplate either a bigger bailout fund or open-ended debt purchases from the European Central Bank as a lender of last resort.

So, if Germany doesn't move significantly on any of those issues (or at least not without protracted, soul-searching domestic debates and/or tortuous EU Treaty changes), creditor strikes can reasonably be expected to spread elsewhere in the zone until some clarity is restored. The fog surrounding the functioning and makeup of the EFSF rescue fund and now Italian and Greek elections early next year  -- not to mention the precise role of the ECB in all this going forward -- just thickens. Why invest/lend to these countries now with all those imponderables.

Where it all pans out is now anyone's guess, but an eventual collapse of the single currency can't be ruled out now as at least one possible if not likely outcome. The global consequences, according to many economists, are almost incalculable. HSBC, for example, said in September that a euro break-up would lead to a shocking global depression.

from Global Investing:

Euro exit-ology

Whether or not it's likely or even a good idea, talk of Greece leaving the euro is no longer taboo in either financial or political circles.  What is more, anxiety over the future of the  single currency has reached such a pitch since the infection of the giant Italian bond market that there are many investors talking openly of an unraveling of the entire bloc. But against such an amplified "tail risk",  it's remarkable how stable world financial markets have been over the past few turbulent weeks -- at least outside the ailing sovereign debt markets in question.

Yet, focussing on the possible consequences for Greece of bankruptcy and euro exit has now become an inevitable part of investment reseach and analysis. In a note to clients on Tuesday entitled "Breaking Up is Hard to Do", Bank of New York Mellon strategist Simon Derrick sketched some of the issues.

One issue he pointed out,  and one raised in the September Spiegel online report, was the chance of invoking Article 143 of the Treaty on the Functioning of the European Union, which permits certain countries to "take protective measures" and which could be used to allow restrictions on the movement of capital in order to prevent a flight of capital abroad.

Europe’s recession trips up economists (again)

Europe’s economy is contracting at a steeper rate than most city economists recognise – and not for the first time.

While tiny Greece stole the headlines last week, a calamitous set of business surveys pointed to imminent recession for the enormous euro zone economy. Even a month ago, that was thought unlikely by most economists.

If city economists weren’t employed by global finance institutions, lots of them might make a living by closing barn doors after the horses have fled. Last week’s purchasing managers indexes (PMIs) were further proof of this.

Euro zone crisis: It’s Germany’s fault

The reigning narrative of Europe’s financial turmoil is that profligate European states, agglomerated all too offensively by a swine-referenced acronym, are forcing the continent’s wealthy, prudent northern countries to come to their rescue. Not so, according to two policy experts who spoke this week at a conference on the euro zone crisis at the University of Austin’s Lyndon B. Johnson School of Public Affairs.

They argue that labor reforms in Germany prevented the wages of manufacturing workers from rising after monetary union had been completed, making the country more competitive at the expense of its southern peers. Joerg Bibow, a professor of economics at Skidmore College, gives his view of events:

Germany’s wage trends have been the most important cause of the euro zone crisis. Those wage trends created an asymmetric shock that destabilized Europe.