MacroScope

An action-packed weekend with both good and bad news for the euro zone, which may — net — leave its prospects little clearer.

Item 1: The IMF came up with $430 billion in new firepower to contain the euro zone-led world economic crisis, although some of the money will only be delivered by the BRICS once they have more sway at the Fund. Nonetheless, the figure at least matches expectations and could give markets pause for thought. The official line is that it is for non-euro countries caught up in the maelstrom but no one really believes that. If a Spain is teetering, IMF funds will be there. Together with the 500 billion euros rescue fund set up by the euro zone, there is still barely enough to ringfence both Italy and Spain if it came to it. But will it come to it?

Item 2: Socialist Francois Hollande came out top in the first round of the French presidential election and is now a warm favourite to win. Some fear that could weaken the Franco-German motor which must be humming smoothly if further crisis-fighting measures are to be convincing. Others say he is essentially a centrist who, either way, will be constrained by the realities of the euro zone situation. Domestically, his focus on tax rises over spending cuts and a slower timetable for cuts could drive up French borrowing costs. Attempts by Hollande and President Nicola Sarkozy to woo the substantial votes that went to the far right and far left could lead to some nerve-jangling campaigning messages for the markets to swallow in the run-up to the May 6 second round.

Item 3: The left-field event of the weekend was the collapse of the Dutch government over budget plans. The hawkish Dutch could now delay ratifying the EU’s new fiscal pact. Finance minister De Jager, a hardliner, promises to try and cobble together enough support in parliament for a tough budget but there is absolutely no certainty he will succeed. The standoff raises the prospect of a rating cut and an even smaller band of top-rated euro zone members. Early elections, and a period of limbo, are quite likely – a negative for the euro zone which could well balance out the progress made at the IMF. And polls suggest popular support for austerity is waning in even this “core” euro zone member.

The euro is on the back foot, getting limited support from the IMF deal, with looming Italian and Dutch debt auctions casting a long shadow. Safe haven German Bund futures are up at the open, French bond futures are down, which tells you something. Dutch debt will doubtless come under pressure. The main focus remains on Spain and Italy with the latter trying to sell a variety of debt through the week against an unfavourable backdrop.
Concerns about Spain in particular are well justified but it is not yet close to the precipice. The banks are at the heart of the country’s problems and are carrying the biggest burden of bad loans since 1994. They will almost certainly need more capital at some point. On the other hand, the central bank points out that thanks to the ECB’s three-year money offer the banks have loaded up on cash to the extent that their funding needs are covered for this year, and maybe next too. Add to that the fact that Spain has shifted half its government debt issuance for 2012 in the first third of the year and it is clear it has some time to turn around market sentiment, which soured sharply when Madrid reneged on an agreed deficit target back in March.

With reporting from Steven C. Johnson and Nick Olivari

A lot of time and money is spent on high-profile multilateral gatherings like this weekend’s International Monetary Fund meeting in Washington. The central story this time is the Fund’s effort to raise more funds (no pun intended), which appears to have been successful as G20 nations committed more than $430 billion in new funds.

French Finance Minister François Baroin, speaking to reporters at a press briefing on the sidelines of the IMF meeting, greeted the news with optimism:

Clearly, the reinforcement of the IMF with more than $400 billion in new resources and its effects on confidence will contribute to financial stability in the euro zone.

Focus for the euro zone is firmly on Washington with G20 policymakers gathering ahead of the IMF spring meeting. The Fund is seeking an extra $400 billion-plus in crisis-fighting funds which, tallied with the $500 billion euro zone rescue fund about to be established, adds up to a meaningful firewall for the markets to ponder before they consider pushing Spain and Italy to the edge.

But as many sage minds are saying – U.S. Treasury Secretary Timothy Geithner among them – a firewall does not solve the root problems of the euro zone debt crisis. As our very own Alan Wheatley puts it, “It is not obvious why a stronger firewall should encourage anyone to enter a burning house”. Nonetheless, Reuters polling yesterday ascribed only a 25% and 13% chance respectively to Spain and Italy needing an international bailout.

If the IMF falls short, given the jittery mood in financial markets, that could be cue for a further sell-off. The IMF has pledges of $320 billion so far. The Chinese and British have yet to show their hands and the BRICS led by Brazil are demanding more power at the Fund before handing over extra cash. German Finance Minister Wolfgang Schaeuble told us earlier in the week that conflating those two issues was not acceptable so there is potential for a rift. The U.S. and Canada have already said they will provide no more funding. Finance ministers and central bankers from the Group of 20 advanced and emerging economies had dinner on Thursday night, ahead of a longer session on Friday.

Brace yourself for a blizzard of numbers.

EU finance ministers gathered in Copenhagen are poised to decide precisely how much firepower their new rescue fund – to be launched mid-year – will have. A draft communiqué suggests that as of mid-2013, presuming no new bailouts have been required in the interim, the combined lending ceiling of the future ESM and existing EFSF bailout funds will be set at 700 billion euros (500 billion pledged to the ESM plus the roughly 200 billion already committed to Greek, Irish and Portuguese rescue programmes).

Up to mid-2013, if 700 billion proves to be insufficient — i.e. someone else needs bailing out — euro zone leaders will be able to bolster it with the 240 billion euros as yet unused in the EFSF, according to the draft, although German Finance Minister Wolfgang Schaeuble said last night that 800 billion should be the absolute limit.

Sorry, there’s more. Because the ESM will not have its full 500 billion euros capacity on day one – it will build up over time – the real available figure for the next year is more like 640 billion euros.
Confused? You should be.

Big debt test for Italy which will sell 8 billion euros or more of longer-dated bonds. A short-term T-bill sale went okay on Wednesday but a day before, the secondary market reacted negatively to a sale of zero-coupon and inflation-linked bonds, pushing Italian yields higher.

The glut of ECB three-year money has ensured Italian and Spanish auctions have sailed out of the door so far this year but there will be no more largesse from the central bank so be on the look out for signs of that support fading. Analysts expect this sale to go well with Italian banks wading in again.

Euro zone money supply data on Wednesday showed Spanish and Italian banks stocked up on government bonds in February – and that was before the ECB’s second instalment of money creation to the tune of 500 billion euros. So bond sales should be underpinned for some time yet though it is clear that the central bank has bought policymakers time rather than solved the root problems.

Conflicting pressures for the euro zone bond market today – a strong signal from Germany that it is willing to increase the firewall built around the currency bloc but ongoing concerns that Spain is being dragged into the mire.

Litmus tests are provided by an auction of a mixture of Italian debt worth up to four billion euros and the sale of short-term Spanish t-bills. While Spanish yields on the secondary market have come under pressure there has been no sign yet that primary sales will have any difficulty, given the more than 1 trillion euros of three-year ECB money sloshing round the financial system.

Italian Prime Minister Mario Monti and Spain’s Mariano Rajoy are both in South Korea for a nuclear summit and could well break cover.