The end of austerity? Not likely
It was Bill Clinton who, after the 2000 U.S. election was thrown into turmoil by Florida’s hanging chads, said the American people had spoken but it was going to take a little time to work out what they had said. No such dilemma in Greece. A plague on both your houses was the message for the traditional ruling parties PASOK and New Democracy, a result that makes a stable government look a remote possibility and puts a very real question mark over its bailout programme.
Today, the largest party New Democracy will try to form a coalition. Given what they’ve said, the left-wing Left Coalition which leapfrogged PASOK into second place cannot be part of a government committed to the bailout terms so it looks like the two traditionally dominant parties — two seats short of an overall majority between them — must seek support from elsewhere or face fresh elections which could well give an even more fractured result. One thing worth noting is that even the resurgent anti-bailout parties mostly say they want to stay in the euro zone so maybe there’s soom room for negotiation.
The euro has dived to a three-month low, Bund futures have posted yet another record high and European shares are down so we’re right back in fear mode.
Two big questions flow from all that: 1. Could this vote, and socialist Francois Hollande’s victory in France, shift the growth/austerity debate? 2. Does Greece, even its possible euro exit, still have the power to spread damaging contagion to the rest of the euro zone?
On the growth front, the answer is only up to a point because Berlin and the European Central Bank — and the markets — won’t wear anything that will dilute debt-cutting programmes much, whatever the more friendly rhetoric suggests. Italian premier Mario Monti, a man desperate for growth, talked to Hollande, Germany’s Angela Merkel and Britain’s David Cameron among others after the elections last night, presumably to push that agenda and the argument is gaining force.
EU economics chief Olli Rehn chipped into the growth debate over the weekend, suggesting there is some leeway to temper debt-cutting drives in order to leave scope for growth. But again, details were elusive. Rehn also said those countries under the microscope had to convince the markets and policymakers of their capacity to put their fiscal houses in order. This sounds rather like having your cake and eating it, or at least reaffirms what we’ve been saying — that there may be some limited fiscal wiggle room, but only as much as the markets will allow, which is not much.
So the growth strategy stills seems to rest on structural reforms (which will take years to bear fruit), plus reconfiguring some EU funds and a beefed up European Investment Bank. Those who really count — Merkel and Draghi at the top of the list — are talking up growth measures while insisting the austerity drive must not be dimmed. The markets would probably respond well to stimulus which did not fundamentally undermine debt reduction. But that’s some trick. And what’s on offer so far will not do the trick. Will something more profound be cooked up for the end-June EU summit?
Euro election fever
We will return on Monday knowing whether the Greeks have elected a pro-bailout government and probably to find socialist Francois Hollande – the man leading the growth strategy charge – as the new French president.
An Hollande victory could cause some jitters given his rhetoric about the world of finance. But we’ve looked at this pretty forensically and there may not be much to scare the horses. Yes he is making growth a priority (but even the IMF is saying that’s a good idea) yet his only fiscal shift is to aim to balance the budget a year later than incumbent Nicolas Sarkozy would. Contrary to some reports, he is not intent on ripping up the EU’s fiscal pact and of course the bond market will only allow so much leeway.
The heavyweight Economist magazine may have labelled socialist Hollande “dangerous” but the reality is likely to be that he will rule from the centre and his demands for a dash for growth — and a change to the ECB’s mandate to aid it — will be tempered. Spain has shown everybody that too much fiscal loosening will be pounced upon by the bond market and while there is a lot of talk about a growth strategy for Europe, what we’ve heard so far amounts to tinkering.
While an Hollande victory looks priced in, Greece still has some power to shock the euro zone.
If the two main Greek parties – PASOK and New Democracy – fail to win enough votes to govern together, they may have to turn to a fringe anti-bailout party which would put a big question mark over Athens’ ability to stick with the austerity terms demanded by its international lenders. However, the threat of contagion, while still alive, has shrunk. With creditors already having taken a massive haircut, most non-Greek banks completely out or at least having written down anything they hold, a 500 billion euros rescue fund shortly to be in place and the IMF raising an extra $430 billion of its own, the power Greece has to start a domino effect in the euro zone is diminished. The caveat to that is, if it has to be cut some slack by the EU and IMF, Portugal and Ireland would presumably demand the same and then the whole austerity edifice starts to look wobbly again.
Despite the much vaunted growth strategy, the focus remains on structural reforms (which will take years to bear fruit) plus reconfiguring of some EU funds and a beefed up European Investment Bank. It will help, or at least can’t hurt, but what’s being discussed so far does not look like anything like a game changer, breaking the spiral of debt-cutting deepening economic downturns which in turn will make it yet harder to cut debt.
And those who really count — Merkel and Draghi at the top of the list — insist the austerity drive must not be dimmed. The markets would probably respond well to growth measures which did not undermine debt reduction. But that’s some trick.
Tumultuous euro zone week
A week where every facet of the euro zone debt saga will come from all angles.
The major events are the French presidential run-off and Greek general elections on Sunday, May 6. In the former case, a likely socialist Francois Hollande victory could cause some market jitters given his rhetoric about the world of finance. But we’ve looked at this pretty forensically and actually there may not be much to scare the horses. Yes he is making growth a priority (but even the IMF is saying that’s a good idea) yet his only fiscal shift is to aim to balance the budget a year later than Sarkozy would. And, contrary to some reports, he is not intent on ripping up the EU’s new fiscal rules. And of course, the bond market will only allow so much leeway.
If the two main Greek parties – PASOK and New Democracy – fail to win enough votes to govern together, they may have to turn to a fringe anti-bailout party which would put a big question mark over Athens’ ability to stick with the austerity terms demanded by its international lenders.
Even if fears about a hard Greek default or even euro exit result, the threat of contagion looks far smaller. With creditors already having taken a massive haircut, most non-Greek banks completely out or at least having written down anything they hold, a 500 billion euros rescue fund shortly in place and the IMF raising an extra $430 billion of its own, the power Greece has to start a domino effect in the euro zone is very much diminished.
Netherlands’ fractured political parties have managed to put together a budget deal in time to present it on deadline to Brussels on Monday but Spain remains far more a source of concern. Downgraded again, its borrowing costs have soared since the government loosened its 2012 deficit target in March. Data just out shows the Spanish economy has succumbed to recession again. Madrid will hold a bond auction on Thursday, as will France.
As we’ve been saying for a while, hopes that the ECB cavalry will ride to the rescue are wide of the mark, until and unless the crisis takes a distinct turn for the worse.
The European Central Bank holds its monthly meeting in Barcelona on Thursday. No policy change is expected and Mario Draghi will doubtless re-emphasise that by creating more than a trillion euros of three-year money, the ECB has bought time for governments and banks to put their own houses in order. There will be a strong focus on his latest call – for a “growth compact” – though it seems to focus mainly on structural reforms and some capital spending out of EU funds, i.e. nothing that the ECB has to get involved in.
Euro zone: Steps forward, steps back
Steps forward and steps back…
The Netherlands’ fractured political class managed to unite enough last night to reach a deal on a 2013 budget which they say will cut the deficit to 3 percent of GDP as required by new EU fiscal rules. Failure could have undermined the EU fiscal pact before it was even born and undermined the efforts of Italy and Spain to pull clear of the debt supernova.
Shortly afterwards, Standard & Poor’s put the boot in by downgrading Spain two notches to BBB+, saying it could cut the rating further. Most tellingly, it cited the increasing likelihood that the government will have to provide further funds to the banking sector which is beset by property bad debts. Madrid insists it will not have to do so, nor will it look to the euro zone for help. Something will have to give since there is no prospect of troubled banks raising capital themselves.
However, S&P did note the structural reforms already undertaken which should support growth in the long-term and the fact that the ECB’s three-year money operation had reduced the banking risk for now.
Plenty of grist for follow-up today with S&P analysts holding an afternoon teleconference and Spanish data on retail sales, unemployment and inflation all due this morning – none of which is likely to paint a pretty picture.
Maybe the biggest setpiece is the Italian bond auction of up to 6.25 billion euros of five- and 10-year bonds and two other niche issues. 10-year yields are expected to leapfrog 5.5 percent at the auction – up more than half a percentage point from the last such sale a month ago; no surprise given where the secondary market now is. But at that return, demand should be solid. Longer-term paper is often trickier to sell, given the greater uncertainty built in to the timeframe, and generally requires more foreign buying. The Italian treasury has put a wide target range of 3.75-6.25 billion euros on the sale to reflect that.
With French and Greek elections looming, the ECB apparently sitting on its hands, the euro zone slipping back into recession and Spanish and French debt to be sold next week, it doesn’t look like there’s going to be any let-up.
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.
Election fever hits the markets
We’re not talking about the U.S. presidential vote, though that does cast another layer of uncertainty over the outlook. Rather, investors are focused on even shorter-horizon events, as evidenced by this jam-packed electoral worry list from Marc Chandler, currency strategist at Brown Brothers Harriman:
This weekend’s first round of the French presidential election kicks of the quarter that will include:
* Greek national elections, where polls warn that the current coalition government may not be returned, increasing the uncertainty.
* Italian municipal elections which will be, at least in part, a referendum on Monti, who has seen his support wane since the labor reform was unveiled.
* Two German state elections, which may see the FDP further marginalized, making a grand coalition next year more likely.
* Irish referendum on the fiscal compact. Due to qualified majority procedures, an Irish rejection would not prevent the adoption of the fiscal compact, but would jeopardize Irish access to the ESM, should it be needed.
* After the second round of the French presidential election in early May, there is the parliamentary election in June.
The Law of Diminishing Greeks
The Law of Diminishing Returns states that a continuing push towards a given goal tends to decline in effectiveness after a certain amount of effort has been expended. If this weren’t the case, Usain Bolt would be able to run the mile in less than 2-1/2 minutes.
From an economic standpoint, this law now seems to be fully in force in Greece. The latest jobs figures from the twice-bailed out euro zone country paint a bleak numerical picture of the impact of unrelenting austerity in ordinary Greeks, regardless of whether it was self-inflicted or not. To wit:
More than one in five Greeks is unemployed.
There are more young people without a job than with one.
The record 1.08 million people without work in January was a 47 percent tumble in a year.
Putting aside for the moment the question of what such a condition means for political dissent, there is now the issue of whether any of this austerity-fueled pain is actually helping the Greek economy.
Austerity mixed with the inability of euro-tied Greece to devalue its currency means Greece is now in its fifth year of recession. As for job-creating small and medium -sized businesses, the latest projections are that more than a net 130,000 of them will have shut down over two years by the time 2012 is over.
The biggest example of the Law of Diminishing returns, however, is the impact all this is having on what ails Greece in the first place — its budget.
Unemployed people offer no revenue to the government in terms of income tax and far less in sales tax than they would if they were working.
Euro zone perspective – nowhere near out of the woods
After the Easter break, a bit of perspective — to paraphrase the immortal Spinal Tap, maybe too much perspective.
Over the past two weeks, Spanish and Italian borrowing costs have continued to rise – in the former’s case they have now relinquished more than half their fall since December and are heading back into the danger zone. Stocks have also appeared to have given up on their first quarter rally, presumably testament to the realization that the ECB and other top central banks are unlikely to be writing any more blank cheques for banks to reinvest.
Late last year, it was Italy that seemed to have the power to drag Spain into the debt crisis mire. Now, it’s the other way round and after the ECB anaesthesia wears off, it’s clear the euro zone patient is still sickly.
The European Commission will cast an eye over Spanish budget plans at some point this week. Spanish risk premiums have leapt since Prime Minister Mariano Rajoy defied Europe in early March by unilaterally easing Madrid’s 2012 deficit target. The silver lining for Madrid is that it has taken advantage of the benign market conditions early in the year to clear almost half its 2012 debt issuance needs and Rajoy is pushing through sweeping labour reforms and savage spending cuts. The trouble is that policy mix is likely to drive Spain further into recession – a recipe for debt to rise not fall.
Approaching elections in Greece and France throw further uncertainty into the mix. The former could weaken austerity resolve and the latter may elect a socialist president intent on rewriting the bloc’s new fiscal rules.
After weak U.S. jobs data on Friday, even a surprise Chinese trade surplus in March – suggesting it’s fabled soft landing is on track – has failed to lift equities. European stocks have dropped more than one percent in early post-holiday trade and safe haven German Bunds have jumped at the open with yields at their lowest level since September. For the first time this year, the markets have reverted to a glass half empty rather than half full bent.
The U.S. data overhang continues to be the strongest driver for now but a wobbly Spanish bond auction last week is also fresh in investors’ memories, given a big Italian debt sale looms on Thursday.
Today in the euro zone
Investors who bought Greek default insurance discover how much they will be paid today. Memories of the chaos that flowed from CDS payouts after the collapse of Lehmans mean there is a degree of nervousness but the signs are this will be nothing like as serious.
A payout of around $2.5 billion to holders of the insurance contracts on Greek bonds will not cause the calamity once feared by euro zone politicians and the ECB as it represents a drop in the ocean of losses investors have already taken on money lent to Greece. That doesn’t mean, however, that a few banks have not been foolish enough to write vast amounts of contracts on Greek debt which will now fall due.
There is a complex auction process to go through where bonds are bought and sold in order to determine a final price, or ‘recovery rate’. That will also give a more accurate guide to the market outlook for Greece since the new bonds issued as part of the bond swap are barely being traded so far. That view ain’t likely to be pretty.
The European Financial Stability Facility — the euro zone’s rescue fund — is busy raising money for the Greek bailout to meet its 109 billion euro contribution. It has asked BNP Paribas, Commerzbank and DZ Bank to arrange a conference call with investors on Monday to discuss a potential new bond issue with a 20-30 year maturity, according to banking sources. This will be the first time it has attempted to sell bonds of this length of maturity. EFSF chief Regling will field questions from potential buyers.
Not much for markets to get their teeth into yet. German Bunds have edged up while European stock futures opened flat. The Greek central bank issues a monetary policy report today in which it is likely to keep up the pressure for the government to pursue its economic reform pledges with alacrity. The Bundesbank issues its monthly report at 1100.
Big focus this week will be on Italian premier Mario Monti’s efforts to drive through labour reforms in concert with trade unions. The largest union says a deal is “impossible” by an end-of-week deadline despite signs of watering down of measures by the government already. A lot hangs on this. A number of key factors have moved the euro zone debt crisis on from critical to chronic, top of the list was the ECB’s creation of a trillion euros of three-year money but not far behind came the elevation of Monti and the hope invested in him that he can turn the Italian economy around. If the euro zone’s fourth largest economy fell over, the currency bloc really would be on the skids.
An eerie euro zone calm
I don’t want to be the idiot who asked “is it all over?” … but is it all over?
Almost certainly not, is the answer. Greece is shored up for now but Portugal will probably need to follow it in seeking a second bailout and Spain, heading back into recession, will have to make deep, deep cuts over the next two years to meet EU deficit targets. Greek and French elections could easily upset the apple cart, the former producing a fractured government with less will to tread the austerity path, the latter a new president who wants to renegotiate the bloc’s new fiscal rules (though neither are guaranteed).
In Italy, a lot of faith continues to be placed in Monti but the proof of his ability to deliver the structural reforms needed to regalvanise the economy has yet to be seen. On that front, the Italian government is talking with trade unions during the week on radical reform of labour market rules, with the aim of clinching a deal next week.
There are a number possible potholes for the euro zone’s new fiscal pact not just in France — an Irish referendum (they’ve lost those before), signs of the Dutch governing coalition splintering over the issue as well as Francois Hollande’s vow to renegotiate it for France. And Germany has not yet dropped its opposition to a larger bailout fund and now faces complicated regional elections.
Even if all the stars are aligned, Italy, Spain, Portugal (let alone Greece) face years of economic hardship before the reforms bear fruit and cuts are finished with. The ECB’s wall of money and the likelihood that a strong euro zone firewall will be in place by mid-year have clearly reduced the existential threat to the currency bloc substantially. But so much of this is to do with market sentiment, currently benign, that it’s not hard to construct a scenario later this year where it could sour again.
While Greece is now firmly in election mode, on Monday the default insurance taken out on Greek bonds will be settled. It looks like around a net $2.5 billion will be paid out, not remotely threatening in a systemic sense. The question is: Is there a bank out there with a horribly exposed position?
For now, for crisis junkies – which most of us have become – there’s a slightly unnerving calm taking hold. Markets, having gorged on central bank cash, are firmly in glass-half-full mode, maybe three-quarters full. The three big disaster hedges – gold, AAA debt and volatility indices – are all now in full retreat. On the other hand, stocks and other assets have rallied hard since the start of the year and can’t do that forever.
