MacroScope

Italy gives new bite to euro zone crisis

Don’t start putting out the tinsel yet. Just when we thought we had a smooth glide path into Christmas the euro zone has bitten back.

Over the weekend, Italy’s Mario Monti called Silvio Berlusconi’s bluff and said he was pulling the government down which will mean early elections in February. The budget bill will be passed and then the country will be in a potentially precarious state of limbo as parliament is dissolved. Italian bond futures have opened more than a point lower, which denotes a reasonable measure of alarm, although the safe haven Bund future has only edged up so we’re far from panic mode.

The big question is whether a government results that will stick to Monti’s agenda and whether he himself will have a prominent role to play in the administration. There are constitutional difficulties to keeping Monti as prime minister since he has said he would not stand at the election, though he has also said he would be prepared to step in again if no stable government is formed. Most likely, presuming a government is elected that supports his reforms, is that he will play a key role but not take the top job.

That would not be possible if Berlusconi’s bloc won – the result that would really spooks markets – but on the basis of the old adage that the assassin never wears the crown, this should not be good for Berlusconi. Well behind in the polls, he now has less time to turn things around and could be blamed by the public for withdrawing support for Monti’s technocratic government. Centre-left leader Bersani looks to be in pole position and is signed up for much of Monti’s reform agenda. But if we get a messy, fractured result in February, bond market pressure could seriously escalate again. In a country that must be wearying of its economic plight and deep recession, nothing is certain.

If markets do react nervously, the backwash will lap at Spain’s shores and, if it persists, could possibly tilt the balance in favour of Madrid seeking help from the euro zone rescue fund and the ECB. But we’re a long way from that yet. Much of this may be up for discussion in Oslo today where EU leaders are heading to pick up the Nobel Peace Prize. With an EU summit due at the end of the week it would seem too good an opportunity for meangingful talks to turn up.

America is not Greece: Low funding costs give U.S. government room to borrow

Is the U.S.on the road to Greece, as some politicians have proclaimed?

Most economists say the comparison is nonsense. At a towering $15 trillion, the U.S. economy is not only the world’s largest, it is also more than 50 times the size of Greece’s. This gap makes any type of comparison difficult – it would be like analyzing trends in Maryland in relation to the entire euro zone.

Another key difference: Unlike Greece, the U.S. actually controls its own currency. That means a debt default is effectively impossible. This reality, coupled with strong monetary stimulus from the Federal Reserve, helps explain why U.S. bond yields remain near historic lows despite larger deficits.

Mark Weisbrot, co-director of the progressive Center for Economic and Policy Research in Washington, says a country’s interest burden is far more important than its total debt levels in determining the government’s ability to service it. He argued in a recent editorial:

Calm after the storm

After months of bickering and struggle, the euro zone and IMF have agreed on a scheme which will notionally cut Greece’s mountainous debt to a level they view as sustainable in the long-term. Athens has now launched a buyback of its debt at a sharp discount from private creditors which should wipe 20 billion euros of its debt pile – a key plank of the plan.

Is the problem solved? Absolutely not. But has Germany achieved its goal of delaying any disasters, or really tough decisions, until after its elections in the Autumn of 2013? Almost certainly. So we could (famous last words) be in for a period of relative calm on the euro zone crisis front.

German Chancellor Angela Merkel and her finance minister have begun quietly hinting that euro zone government and the European Central Bank may eventually have to take a writedown on the Greek bonds they hold to make Athens’ debt controllable. That won’t happen for at least two years but in the meantime, bailout money will flow and Greece will survive.

What Greece’s latest debt deal might mean for Ireland and Portugal

Another week, another Greek debt deal. Third time’s a charm, EU and Greek politicians assure us. Under the agreement, Greece’s international lenders agreed to reduce Greece’s debt load by 40 billion euros, cutting it to 124 percent of gross domestic product by 2020 through a package of steps.

Marc Chandler, head of currency strategy at Brown Brothers Harriman, points out “an under-appreciated twist to the plot”: the Greek deal has potential implications for other bailed out European states like Portugal and Ireland.

European officials adopted a principle of equal treatment under the framework of the EFSF. Essentially, this means that consideration given out to Greece applied to the other countries who receive EFSF assistance, namely Ireland and Portugal.

Glimmer of Greek hope

There are signs of headway from Athens where we have just snapped a government source saying the IMF accepts Greek debt is “viable” if it falls to 124 percent of GDP in 2020, rather than the 120 that it had previously decreed was the maximum sustainable level.. The source said fresh measures have been found to reduce debt to 130 percent of GDP by 2020, leaving another 10 billion euros to be covered.

At the latest failed meeting of euro zone finance ministers on Tuesday, we confirmed that the EU/IMF/ECB troika had calculated Greek debt would only fall to 144 percent of GDP in 2020 without further measures, meaning roughly 50 billion euros needed to be knocked of Greece’s debt pile. A report circulated at the meeting concluded (apologies for the number soup) that debt could only be cut to 120 percent of GDP in eight years if euro zone government agreed to take a writedown on their loans, which they will not do for now.

If the IMF will now accept 124 percent as a target that means 20 percentage points of GDP – about 40 billion euros – would have to be lopped off Greece’s debt pile. If they are now only 10 billion short, then measures amounting to 30 billion have been found. It’s hard to believe that could have come from the Greek side which has already slashed to the bone, so maybe some or all of the options we know are on the table — a Greek debt buyback at a sharp discount, lowering the interest rate and lengthening terms on the loans and the ECB foregoing profits on its Greek bondholdings – have been agreed to.

If Greek talks are tough, check out the EU budget

The EU budget summit, which could turn into a marathon as it tries to nail down monies for the next seven years, begins today. With the euro zone repeatedly failing to nail down a Greek deal, the EU would be well advised not to let this negotiation fall apart too. Having said that, there is little sign of great concern in market pricing – presumably the ECB’s pledge to buy government bonds in whatever amount it takes to steady the bloc continues to suppress investor nerves and short sellers.

Net contributors to the budget including Germany, France and Britain want to cut 100 billion euros from the European Commission’s draft budget proposal, but differ over which areas to cut. Meanwhile, the main beneficiaries of EU funding such as Poland, Hungary and the Czech Republic oppose cuts. The meeting is intended to lay the groundwork for political agreement on the budget by EU leaders at their final summit of 2012 in December. It will last two days, maybe more and it could well be that no agreement is reached. Officials say only a cut in real terms – for the first time ever – is likely to do the trick.

Back to Greece and prime minister Samaras will meet Eurogroup chief Juncker in Brussels although he is now largely a passive, angry bystander in this process. While Juncker’s assertion in the early hours of Wednesday morning that a deal was only held up by complex technical matters has some truth to it, there is a far deeper split to be closed.

French downgrade to give way to Greek debt deal

Big event overnight was the downgrading of France to Aa1 by Moody’s, bringing it in line with Standard & Poor’s which cut back in January. There are some funds (even in this age of AAA scarcity) which will only invest in top notch debt and take their cue to exit once two agencies have dropped that rating, but the immediate impact is unlikely to be dramatic. The euro has slipped on the news, French government bond futures have dropped about a quarter of a point and safe haven German Bund futures have edged up. “Although it’s not great, the market doesn’t seem too worried,” one trader said.

However, it does throw a spotlight on the gap between France’s economic health (lack of it) and the record low costs it can borrow at. We’ve written plenty of good stuff on this already and French finance minister Moscovici gave his response to us last night. Interestingly, it wasn’t an attack on the ratings agencies, which we’ve seen before from Europe in these circumstances. Instead, he said it was an alarm bell telling the government to pursue structural reforms and reaffirmed his commitment to meet budget deficit targets. He noted that France continued to enjoy record low yields after S&P cut early in the year. The only thing he really took issue with was Moody’s view of the large risks to France’s banks. It warned it could cut France’s rating further.

As the day progresses, thoughts will turn to Greece and this evening’s meeting of euro zone finance ministers. We’ve had a strong exclusive readout of what is likely – an endorsement in principle to unfreeze loans to Greece but a final go-ahead for December disbursement only after a few final reforms are enacted in Athens. Berlin has suggested bundling together the next few Greek bailout tranches in order to pay over 44 billion euros if a green light is given. Others want only the next tranche of 31 billion to be handed over at this stage. Either way, that will keep the show on the road but there is plenty more to be decided yet.

The Greek “cliff”

Some key positions were staked out on Greece over the weekend – ECB power-behind-the throne Joerg Asmussen became the first euro policymaker to say on the record that euro zone finance ministers meeting on Tuesday would be intent only on finding a deal to tide Greece over the next two years. But IMF chief Christine Lagarde told us in an interview that she would push for a permanent solution to Greece’s debts to avoid prolonged uncertainty and further damage to the Greek economy.
  
Sounds like those two positions could be mutually exclusive. However, it may be that something like a behind-the-scenes pledge from the German government that it will act decisively after next year’s election will keep the IMF on board.

Eurogroup chief Jean-Claude Juncker said at the weekend that intensive work was being done on a compromise with the IMF and progress was being made, after the euro zone sherpas put their heads together on Friday. And even hardline German Finance Minister Wolfgang Schaeuble said a deal had to be struck on Tuesday and would be. Juncker and Lagarde clashed last week over his suggestion that Greece should be given an extra two years, to 2022, to get its debt/GDP ratio down to 120 percent, the level the IMF has decreed is the maximum sustainable. Lagarde looked surprised and firmly rejected the idea.

IMF officials have argued that some writedown for euro zone governments is necessary to make Greece solvent but Germany has repeatedly rejected the idea of taking a loss on holdings of Greek debt, saying it would be illegal. 
Among ideas under consideration to plug the funding gap are further reducing the interest rate and extending the maturity of euro zone loans to Greece, a possible interest payment holiday and bringing forward loan tranches due at the end of the programme, according to euro zone sources.

Greek debt — a riddle, wrapped in a mystery, inside an enigma

So said Winston Churchill of Russia. The Greek debt saga isn’t quite that unfathomable but the economic necessities continue to clash with the political realities.

Eurogroup Working Group – the expert finance officials from 17 euro zone nations who do the clever preparatory work before their finance ministers meet – will convene to today try and get the Greek debt process back on track after a ministerial meeting got nowhere on Monday and in fact ended up in an unusually public spat between its chair, Jean-Claude Juncker, and IMF Managing Director Christine Lagarde.

The Eurogroup plus Lagarde will meet again next Tuesday and there are big gaps to bridge although we intercepted the IMF chief in Manila this morning, insisting that a deal was possible, or at least that’s one way of reading her “it’s not over until the fat lady sings” quote.

Greek show still on the road

The Greek government pulled it off last night, winning parliamentary approval for an austerity package which offers yet more deep spending cuts, tax rises and measures to make it easier and cheaper to hire and fire workers. But boy was it tight. With the smallest member of the coalition rejecting the labour measures, Prime Minister Antonis Samaras carried the day by just a handful of votes. The overall budget bill is expected to be pushed through parliament on Sunday.

So the show remains on the road and this government has shown more resolve than its predecessors which may buy it some goodwill from its lenders. Attention today turns to the monthly policy meeting of the European Central Bank, a key player in negotiations to put Greece’s debts back on a sustainable path.  Mario Draghi could well rule out taking a haircut on the Greek bonds it holds, something the IMF has pushed it and euro zone governments to do but which Germany and others won’t countenance.  However, the ECB could forego profits it has made on Greek bonds it bought at a steep discount. Those profits have to be funneled through national euro zone central banks and would only be realized when the bonds mature but it would still help.

Greece is set to get two more years to make the cuts demanded of it and EU economics chief Olli Rehn told us yesterday that lengthening the maturities on official loans to Greece and lowering interest rates on them could be done but a haircut was out. There is the possibility of a meeting of the Eurogroup Working Group (the expert officials who prepare for euro zone finance ministers’ meetings) but it seems less likely that a deal will be struck at next Monday’s Eurogroup meeting, with officials now giving themselves until the end of November to come up with something. There were suggestions that Washington had urged big decisions to be put off until after the presidential election. True or not, that roadblock is now out of the way.