MacroScope

The ying.
Sources told us last night that Spain may recapitalize stricken Bankia with government bonds in return for shares in the bank. That would presumably involve an up-front hit for Spain’s public finances (it is already striving to lop about 6 percentage points off its budget deficit in two years) which might be recouped at some point if the shares don’t disappear through the floor.
The ECB’s view of this will be crucial since the plan seems to involve the bank depositing the new bonds with the ECB as collateral in return for cash. If it cries foul, where would that leave Madrid?

Spain’s main advantage up to now – that it had issued well over half the debt it needs to this year – may already have evaporated after the government revealed that the publicly stated figure for maturing debt of the autonomous regions of 8 billion euros for this year is in fact more like 36 billion. Catalonia said late last week that it needed central government help to refinance its debt.  If more bonds are required to cover some or all of Bankia’s 19 billion euros bailout, Spain’s funding challenge in the second half of the year starts to look very daunting indeed.

The yang.
Latest Greek opinion polls, five of them, show the pro-bailout New Democracy have regained the lead ahead of June 17 elections although their advantage is a very slender one. If the party manages to hold first place, and secures the 50 parliamentary seat bonus that comes with it, then it looks like it would have the numbers to form a government with socialist PASOK which would keep the bailout programme on the road … for a while.

After a disastrous campaign first time around, maybe New Democracy has got its act together. Its leader, Antonis Samaras was out yesterday bluntly saying his anti-bailout SYRIZA opponents would leave Greece isolated for years and without food, drugs, fuel and power. Sobering stuff. Officials have already told us Greece will run out of money by July if outside money dries up.

Samaras is calling for Greece to be given four years rather than two to make the spending cuts demanded of it. PASOK’s Venizelos says it needs three. Could there be a deal to be done with  Brussels and the IMF there? Maybe, but there does seem to be a distinct lack of sympathy from Athens’ international lenders. Over the weekend, IMF chief Lagarde effectively accused Greeks of being tax dodgers and said she was more concerned about the plight of deprived children in Africa. That caused a storm on her Facebook page, causing her to soften her tone a little. Germany’s interior minister chipped in, ruling out pouring money into a Greek “bottomless pit” and a senior Deutsche Bank executive said it was a failed state.

With Spain’s banking system looking ever more parlous and the Damoclean Sword of Greek elections hanging over the financial markets, next week is not going to be for the faint-hearted.

Stock markets have endured another volatile week, rising early on before falling sharply just before the EU summit, then rising the day after – all this when very little changed on the euro zone landscape. Increasingly, the downward moves are sharper than the upward ones and there is little prospect of things settling before the June 17 Greek elections. It seems everyone is so nervous that if they are sitting on a day of gains, they cash them in double-quick.

Page one of the crisis management manual says get all the bad news out quickly. The handling of troubled Spanish lender Bankia has been an abject failure in that respect. First, the government said it would require about 9 billion euros to shore up, a few days on they are looking at 20 billion. One proposal doing the rounds is to create one nationalized bank out of a number of failed lenders. The big question, to borrow heavily from Louis XV, is: Apres Bankia la deluge?

A telling moment. Before pretty much every showdown EU summit since the debt crisis exploded into life, the leaders of France and Germany have got together beforehand to agree a common strategy. It is a truism that the European motor only works efficiently when its two biggest powers are in accord.

This time, following the election of Francois Hollande as French president, there has been no such meeting. Instead he will talk with Spanish premier Mariano Rajoy in Paris before they head to the Brussels summit.
There, Hollande will press for the currency bloc to start issuing joint euro zone bonds and will run into implacable German opposition that will squash the plan for now.
But the plates are shifting and German Chancellor Angela Merkel looks somewhat isolated.

On euro bonds, Hollande can call on the support of Italy’s Mario Monti and the European Commission among others.
Nonetheless, Angela holds the purse strings so while we will see some modest pro-growth measures agreed (and no doubt trumpeted), there will be no pump-priming that requires extra deficit spending, certainly no mutualising of debt and probably no hint that the likes of Greece and Spain will be given longer to make the cuts demanded of them (though that policy’s time could soon come, depending on how the June 17 Greek elections go).

Greece faces another election on June 17.  Although they reject the austerity required by the bailout, most Greeks want their country to stay in the euro. However Frankfurt and Brussels say it is impossible for Greece to have one without the other: no bailout means no euro and a return to the drachma. Whether the Greek people believe these warnings could have a big impact on the election result.

First place comes with an automatic bonus of 50 seats, meaning even the slightest edge could be pivotal in determining the makeup of the next government.

Click here for an interactive chart showing the latest polls:

After last week’s hefty losses, European stock gained yesterday and are up up again this morning, denoting some optimism about the Wednesday supper summit of EU leaders, which might well be unrealistic.

The European growth measures that we know are in the works – boosting the paid-in capital of the European Investment Bank and plans for ‘project bonds’ underwritten by the EU budget to finance infrastructure – might help a little but will fall a long way short of turning the euro zone economy around, so unless we get something more, on either the growth or the building defences fronts, there’s scope for investor disappointment.

Europe’s international partners continue to demand more dramatic crisis action. After the G8 summit, President Obama was out last night with four demands:
- firewalls to protect countries from Greek contagion (are the ESM and IMF funds now viewed as insufficient?),
- recapitalization of banks that need it (Spain to the fore here presumably),
- A growth strategy to run alongside tight fiscal measures (easier said than done),
- easy monetary policy to help the likes of Italy and Spain keep cutting debt (the ECB thinks its 1 percent rate is very loose and is unlikely to cut soon with inflation above target and will only flood the system with more liquidity in utter extremis)

Some interesting events to  ponder over the weekend, though not many of them came from the G8 summit which, as is customary, was strong on rhetoric but bare of any specific policy measures to tackle the euro zone crisis. However, markets seems to have tired of their panicky last few sessions. German Bund futures have opened lower as investors took profits rather than seizing on any positive news. European stocks have edged up.

It does appear that with the ascension of France’s Francois Hollande, the G8 firmament turned into G7 (or maybe 5 since we didn’t hear much from Japan and Russia) versus 1 (Germany) but as things stand we’re still heading for a fairly anaemic “growth strategy” unless euro zone leaders coalesce behind the notion of giving Spain and Greece longer to make the cuts demanded of them. Spain has moved the goalposts further in the wrong direction, revising its 2011 deficit up to 8.9 percent from 8.5 and blaming the overspending regions. That means its already loosened target of 5.3 percent for this year is now even harder to achieve.

Hollande is talking up the case for common euro zone bonds but that will not wash with Berlin for a long time yet. Sources said Monti used the G8 forum to promote a pan-European bank deposit guarantee fund. Good idea but that too will only be conceivable if the European financial sector is on the point of toppling. And who will underwrite it? There is talk too of allowing the EFSF to lend direct to banks to ease the Spanish government’s reluctance to ask for help. That may have a slightly better chance of success but Berlin doesn’t like this idea either.
Look no further than the German Chancellor’s take on the summit – it was all a great success, she said. Everyone agreed that we need both growth and fiscal consolidation.

So we’ve got the fresh Greek elections we expected and markets, despite the inevitability that we would get here, have reacted with some alarm. European stocks have shed  around 1 percent, and the harbour of German Bunds is pushing their futures price up in early trade. The Greeks will try to form a caretaker government today to see them through to elections expected on June 17.

The key question is whether the mainstream parties can mount a convincing campaign second time around, playing on the glaring contradiction in SYRIZA’s position (no to bailout, yes to the euro) and essentially turning the vote into a referendum on euro membership, which the overwhelming majority of Greeks still support. Don’t count on that. SYRIZA remains ahead in the polls.
To be able to pull it off, PASOK and New Democracy will need some help from Europe. There have already been hints from Brussels that if a pro-bailout government is formed, Athens could be given some leeway on its debt-cutting terms. But equally other voices are saying there is no more room for manoeuvre.

France’s Francois Hollande used his presidential debut to frame help for Greece within his push for a European growth strategy last night, saying he hoped that could also foster a return to prosperity there. He and Germany’s Angela Merkel are due in the United States for a G8 summit at the end of the week where doubtless they will come under heavy pressure to make sure Greece doesn’t bomb out of the euro zone or, if it does, that the effect is contained. Easier said than done. Given a Greek euro exit would probably require rapid concerted reaction from the EU, IMF (to shore up Spain?) and the world’s big central banks (remember the global monetary policy response after the collapse of Lehmans?), planning for that could well be bubbling below the surface at the G8.

Greece is stumbling inexorably towards fresh elections which polls suggest will give the anti-bailout far left a stronger grip on power. Last ditch talks aimed at creating a unity government will continue under the aegis of the president today but the leader of the radical leftist SYRIZA has said he will not turn up. Alexis Tsipras says he wants Greece to stay in the euro but will rip up the bailout agreement. Go figure.
This morning the more moderate left party has said it won’t take part in a government lacking SYRIZA.

A big question is whether the mainstream parties can mount a convincing campaign second time around, playing on the glaring contradiction in SYRIZA’s position and essentially turning the vote into a referendum on euro membership, which the overwhelming majority of Greeks still support. Don’t count on that.

Two ECB policymakers –  Honohan and Coene – were out over the weekend talking about the possibility of a Greek euro exit: there goes another taboo. Policymakers must be running through the hard default and exit scenarios now. We need to be asking.

What happens if Greece leaves the euro? No one can say for sure. But John Davies at WestLB, finds it difficult to envision a benign outcome.

Greece’s economy, at around $300 billion, is very small compared to the euro zone as a whole. The problem is if other countries follow suit – or are pressured in that direction by stubborn financial markets.

Such a scenario doesn’t bear thinking about because it is so horrible.

There is a good chance that the market would immediately trade Portugal towards pre-debt swap Greece levels. The next in line would certainly be Ireland and Spain.

Attempts to form a Greek coalition government appear to be running into the sand with no one prepared to dance with the two mainstream parties, New Democracy and PASOK, raising the probability of a fresh round of elections with all the uncertainty that will entail. The far-left Socialist Coalition will have a stab at forming an administration today but doesn’t really have the numbers to do it.

The only plan that looks like it offers a glimmer of hope is that put forward by PASOK leader Evangelos Venizelos. He is after a “pro-European” coalition and has pledged to spread the cuts Greece has been ordered to make under its bailout programme over three years not two. If a burst of realpolitik every takes hold in Athens (and it’s worth noting that nearly all the parties say they want to stay in the euro), that could just be enough to get others on board. BUT, Venizelos would then have to go to Brussels to persuade the EU to go along with this relaxation of its targets and, on and off the record, officials lined up yesterday to say there was no prospect of that happening.
And his PASOK was the party that was most badly humiliated at Sunday’s election so it’s hard to see how it has a mandate to rule the Greeks, a majority of whom voted firmly against austerity, even it is in a broad coalition.

So new elections next month are likely which leaves a very compressed timeframe and who knows what political landscape will result second time around. The EU/IMF/ECB troika is supposed to return in June and can’t negotiate on the next bailout tranche if there is no government. In any case, Athens is supposed to find 11 billion euros of extra cuts as part of the aid programme and none of the parties are in a position to do that as things stand.