MacroScope

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.