MacroScope

The pain in Spain … spreads to Italy

This morning, we exclusively report that Spanish Prime Minister Rajoy could be about to break another promise by freezing pensions and bringing forward a planned rise in the retirement age.

This latest austerity policy will be political poison at home but will give Madrid more credibility with its euro zone peers since that was one of Brussels’ policy recommendations for the country back in May. We know that at the end of next week the government will unveil its 2013 budget and further structural reforms which all smacks of an attempt to get its retaliation in first so that the euro zone and IMF won’t ask for any more cuts if and when Madrid makes its request for aid.

The pensions shift could well be kept under wraps until regional elections in late October are out of the way. It is less likely that the government can defer a request for help from the euro zone rescue fund, after which the ECB can pile into the secondary market, for that long given some daunting debt refinancing bills falling due at the end of next month.

Rajoy is in Rome today for talks with Italy’s Mario Monti. The Greek and Irish premiers, Antonis Samaras and Enda Kenny, are also there for a centrist political party gathering. They are all expected to hold bilateral with Monti as well. The only member of the euro debt club missing is Portugal although its prime minister is speaking in the Lisbon parliament.

Later in the day, Portuguese President Anibal Cavaco Silva’s consultative State Council meets to discuss government-proposed tax hikes that provoked massive street protests, sharp criticism by business leaders and unions and threatened to cause a rift in the ruling coalition of Prime Minister Pedro Passos Coelho. The president has the power to veto bills but is more likely to call for some sort of a compromise or alternative measures since the government has already said it will continue to discuss the plan with the unions and employers next week.

Spanish bonds on the block

Having done so with a t-bill sale on Tuesday, Spain will continue to try and cash in on the relatively benign market conditions created by the European Central Bank by selling up to 4.5 billion euros of 3- and 10-year bonds. It hasn’t tried to sell that much in one go since early March, when the ECB’s previous gambit – the three-year liquidity flood – had also imposed some calm upon the markets, albeit temporarily (there’s a lesson to be learned there).

Yields are likely to fall sharply from the most recent equivalent auctions but even so, it looks unlikely that Madrid can meet some daunting looking refinancing bills before the year is out, without outside help. Prime Minister Mariano Rajoy’s hesitation about making a request for bond-buying help from the ESM rescue fund, with the ECB rowing in behind, has already pushed Spanish 10-year yields back up towards six percent after a more than two-point plunge since ECB chief Mario Draghi issued his “I’ll save the euro” proclamation in late July.  They had peaked around 7.5 percent before that.

With the ECB having pledged to buy bonds if necessary, but only at the shorter end of the maturity scale, the three-year bonds should be snapped up. The 10-year issue may be a harder sell. The danger is that Spain (and Germany, which is saying Madrid shouldn’t take a bailout unless market pressure returns with a vengeance) dithers for so long that the positive sentiment created by Draghi dissipates completely.

No time for complacency

After a tumultuous fortnight where the European Central Bank, U.S. Federal Reserve, German judges and Dutch voters combined to markedly lift the mood on financial markets, we’re probably in for a more humdrum few days, although a raft of economic data this week will be important – a critical mass of analysts are saying that after strong rallies, it will require evidence of real economic recovery, rather than crisis-fighting solutions, to keep stocks heading up into the year-end.

A weekend meeting of EU finance ministers reflected the progress made, but also the remaining potential pitfalls. Our team there reported the atmosphere was notably more relaxed and Spain’s announcement that it would unveil fresh economic reforms alongside its 2013 budget at the end of the month sent a strong signal that a request for bond-buying help from Madrid is likely in October. If made, the ECB could then pile into the secondary market to buy Spanish debt  if required and hopefully drag Italian borrowing costs down in tandem with Spain’s.

BUT. The Nicosia meeting also exposed unresolved differences between Germany and others over plans to build a banking union. German Finance Minister Wolfgang Schaeuble said handing bank oversight to the European Central Bank is not in itself sufficient to allow the euro zone’s rescue fund to directly assist banks – another key plank of the euro zone’s arsenal. It sounds like that debate went nowhere.
Having largely been the dog that hasn’t barked so far, public unrest is on the rise with big marches in Portugal and Spain over the weekend against further planned tax hikes and spending cuts.

Do they they think it’s all over?

Is everything falling into place to at least declare a moratorium in the euro zone debt crisis?

Well the ESM rescue fund getting a go-ahead from Germany’s consitutional court and the Dutch opting to vote for the two main pro-European parties, following Mario Draghi’s confirmation last week that the European Central Bank would buy Spanish and Italian bonds if required, means things are starting to look a little rosier.

The risks? Next spring’s Italian election, and what sort of government results, casts a long shadow and it is just about conceivable that Spain could baulk at asking for help, given the strings attached, although the sheer amount of debt it needs to shift by the end of the year will almost certainly force its hand. If the Bundesbank mounted a guerrilla war campaign against the ECB bond-buying programme it could well undermine its effectiveness. That is a big if given broad German political support for the scheme. Key countries remain deep in recession with little prospect of returning to growth because of the imperative to keep eating away at their debt mountains, which could eventually trigger a dramatic public reaction. France could well get dragged into that category.

Another euro zone week to reckon with

Despite Mario Draghi’s game changer, or potential game changer, the coming week’s events still have the power to shape the path of the euro zone debt crisis in a quite decisive way, regardless of the European Central Bank’s offer to buy as many government bonds as needed to buy politicians time to do their work.

The nuclear event would be the German constitutional court ruling on Wednesday that the bloc’s new ESM rescue fund should not come into being, which would leave the ECB’s plans in tatters since its intervention requires a country to seek help from the rescue funds first and the ESM’s predecessor, the EFSF, looks distinctly threadbare. That is unlikely to happen given the court’s previous history but it could well add conditions demanding greater German parliamentary scrutiny and even a future referendum on deeper European integration. For the time being though, the markets are likely to take a binary view. ‘Yes’ to the ESM good, ‘No’ very bad.

Dutch elections on the same day look to have been robbed of some of their potential drama with the firebrand hard-left socialists now slipping in the polls and the fiscally conservative Liberals neck-and-neck with the likeminded centre-left Labour party. But there are no guarantees and Germany could yet be robbed of one of its staunchest allies in the debt crisis debate.

Fund managers also fall prey to economists’ euro zone bias

If Reuters polls onthe euro zone this year have proved anything, it’s that forecasts concerning the future of the currency union really boil down to national bias and not just plain economics.

Last week’s global polls of fund managers proved that’s just as true of investors as it is for analysts.

It’s a well-established trend: economists working for institutions based inside the euro zone are far more optimistic about its future than those from Britain or the United States.

Euro zone gymnastics

Sometimes, a week away from the fray can bring perspective. Sometimes, you miss all hell breaking loose.
My last day in the office saw European Central Bank President Mario Draghi utter his “we will do whatever it takes” to save the euro declaration. The markets took off on that, only to sag when the ECB didn’t follow through at last Thursday’s policy meeting.

In fact, it was never that likely that the ECB would rush to act, particularly since Draghi’s verbal intervention had started to push Italian and Spanish borrowing costs lower and the troika of lenders was still musing over Greece. But it seems to me that, despite German reservations, the ECB president has shifted the terms of trade, something market action is beginning to reflect.

There can be little doubt now that the ECB will intervene decisively if required – and the removal of that doubt takes away the main question that has kept markets on edge every since a bumper first quarter evaporated. Yes, there are caveats – notably the fact that Draghi said the ECB would only step in if countries first request assistance. With that will come conditionality and surveillance but it seems highly unlikely that Spain, for example, will be required to come up with any further austerity measures given what it is already doing. Spanish premier Rajoy seemed to soften Madrid’s opposition to seeking help last week, though he said he wanted to know precisely what the ECB might do in return. Until now, seeking sovereign aid has been a taboo for Spain. If that’s changed, it’s also big news.

Euro zone facing autumn crunch?

Spain remains the focus for the markets but here comes Greece racing up on the outside lane. Officials told us exclusively yesterday that Athens is way, way off the targets set by its bailout programme and a further restructuring will be needed. If so, it’s almost inevitable this time that euro zone governments and the ECB will have to take a hit. Are they prepared to? There’s little sign of it so far although a key ally of German Chancellor Angela Merkel said last night that a second haircut was an option.

CDU budget expert Norbert Barthle said Greece would do its level best to stay in the euro zone, and given the losses associated with its departure and the fact that it could also prove a tipping point for Spain, there are powerful reasons to hope that’s true. But, but, but it’s pretty apparent that Athens has little chance of delivering the cuts being asked of it without completely wrecking its economy even if it is cut a bit more slack. And the latter is a big “if” too. It’s hard to see Merkel telling the German public they are going to face another bill to keep Greece afloat. As Barthle said, a second debt write off “would cost us a lot of money”. He also flagged up another problem that has been aired in recent days – that the IMF would probably not stump up any more funds given Greece has not met its stipulations.

The euro zone has indicated it will keep Greece afloat through August while the troika of EU/IMF/ECB inspectors assess the situation but we could be approaching a crunch point in September or October and if we get there the big “contagion” question is back – would a full Greek default or euro zone exit (and by the way some policymakers have floated the possibility of allowing Greece to default within the euro zone because it would be slightly less chaotic) lead to a collapse of confidence in Spain?

Darker and darker

Moody’s put Germany on notice that it might cut its credit rating and did the same for the Netherlands and Luxembourg. It cited a growing chance that Greece could leave the euro zone, and the contagion and costs that could flow from that, as well as the possibility that Berlin might have to increase its support for Italy and Spain. Both are self-evident risks and markets have not really reacted though it’s interesting timing that Spanish Economy Minister de Guindos is meeting his German counterpart, Wolfgang Schaeuble, in Berlin later. The Moody’s warning could also feed into darkening German public opinion about the merits of offering any more help to its sick partners.

German Bund futures opened just 10 ticks lower and European stocks edged higher after a sharp Monday sell-off. A jump in China’s PMI index has helped sentiment a little. The euro remains on the back foot but if it continues to fall that should actually help euro zone economies, making their exports more competitive. We’re programmed to treat government statements with scepticism but it’s hard to argue with the German finance ministry which said last night that the risks cited by Moody’s were nothing new and the sound state of German public finances was unchanged.

Nonetheless, reminders of the depth of the debt crisis are close at hand. So dislocated is the Spanish debt market that is hard to gauge what costs Spain will be required to pay at today’s T-bill auction because a combination of summer holidays and worries about the country’s finances mean trading has virtually dried up. With benchmark bond yields hitting euro-era highs on Monday, however, the debt sale of 3 billion euros in 3- and 6-month bills is likely to be expensive.
Also last night, clearing house LCH.Clearnet SA  increased the cost of using Spanish and Italian bonds to raise funds via its repo service, which could put further upward pressure on already surging yields.

Bridge of Sighs

Greece announced late yesterday that it would need a bridging loan to tide it over until it finds the nearly 12 billion euros of spending cuts demanded by the EU/IMF/ECB troika of inspectors, after which the next tranche of bailout money can flow, probably in September. The troika is due to return next week. There’s no doubt Athens will get the interim money. Jean-Claude Juncker, who chairs the group of euro zone finance ministers, said last week that nobody should fret about Greece’s finances in August. They would be shored up.

Today, Finance Minister Yannis Stournaras is expected to put a draft list of cuts to the leaders of the three parties comprising the country’s ruling coalition, who are rather hemmed in by pledges to voters not to fire civil servants and shun sweeping pensions and public sector wage cuts.

Italian Prime Minister Mario Monti threw in a curve ball last night, saying there was a real prospect that the autonomous island of Sicily could default. It accounts for about 5.5 percent of Italian GDP so shouldn’t wreck the country’s finances but it’s not a step in the right direction. If Italy’s debt mountain of 120 percent of GDP started rising rather than falling, it could be taken very badly by the markets.