All eyes on Wednesday EU summit
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)
Nothing new there but it keeps up the drumbeat of pressure ahead of the EU get-together. We know French President Francois Hollande, with the backing of others, will press the case for common euro zone bonds at the summit and also know that German opposition will not weaken one jot on that score. Spain’s Rajoy is pressing for more ECB involvement, presumably by reviving its bond-buying programme. Given internal opposition to that within the ECB that is probably the least likely measure to be reactivated, yet anyway.
Despite money flowing out of Greek banks, and at least the threat of it spreading more widely if Greece bombed out of the euro zone, there is no hint yet of any planning for any scheme to underwrite bank deposits across the bloc, probably because the ECB and Germany will not countenance underwriting it. The golden rule of this crisis is that red lines have and will be crossed when it reaches breaking point. We’re not there yet.
With so much focus on Greece and Spain, Portugal has been somewhat overlooked in recent weeks but it will quite likely need a second bailout at some stage and if Greece prompts a wave of contagion, it will be firmly and instantly in the firing line.
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?
Austerity light? Maybe a shade lighter
There is a groundswell building in the euro zone that austerity drives should be tempered.
France’s Francois Hollande, favourite to take the presidency next month, said last night that leaders across Europe were awaiting his election to back away from German-led austerity, and even ECB President Mario Draghi called yesterday for a growth pact.
He was rather opaque on how – although he was clear the European Central Bank would not be doing anything more — but his colleague Joerg Asmussen was a little more forthcoming, saying some EU structural funds could be funneled to countries in crisis to boost employment. These sort of ideas are actively part of the mix and could well be enacted at the June EU summit.
Thay also tally with some of Hollande’s policy slate. He is promoting joint European bonds to finance infrastructure projects, greater investment by the European Investment Bank more efficient deployment of EU regional development resources and a financial transaction tax levied help fund youth and education projects. Some of those options are quite likely to happen. Others much less so.
Reality check: The EU’s German paymasters and the ever-present bond market will only tolerate a marginal shift in direction – you need look no further than at what has happened to Spain and its borrowing costs since it upped its deficit target in March — so there will be not much let-up on the debt-cutting front. Nonetheless, there has been a distinct shift in the rhetoric. Even Angela Merkel is pushing for a more broadly-based minimum wage in Germany, which could be construed as a growth tactic.
Dutch finance minister De Jager says multi-party talks about the 2013 budget have been constructive. They will continue today.
The Netherlands is supposed to hand Brussels its budget deficit target next week – the government was targeting 3 percent of GDP but lost its coalition partners, who demanded a softer goal, and collapsed earlier in the week. With elections not due until September, a failure to cobble together a budget deal by the main parties would lead to a dangerous period of uncertainty.
ECB to the rescue? Hold your horses
ECB policymakers from Mario Draghi down will come at us from all angles today. Expect a united front on the main theme of the moment; calls for it to consider yet more liquidity operations essentially creating money and/or resuming its government bond-buying programme. That call was first heard at the IMF spring meeting over the weekend and the ECB president’s response could hardly have been clearer, saying: “None of the advice of the IMF has been discussed by the Governing Council, in recent times at least”.
Since then a number of his colleagues have followed up. The message: they are looking more to inflation now and banks and governments have to put their own houses in order after the ECB gave them time with its colossal three-year money-creating exercise. The ECB’s man in Spain, Gonzalez-Paramo, is already out this morning saying Spain will not struggle to meet its debt issuance target this year despite its rising yields.
The ECB will, of course, act if the crisis drives Europe right back to the brink, it’s mandate will pretty much demand it at that stage but we’re not anywhere near there yet – contrary to what many in the markets believe.
That things are not good is not in dispute.
The Netherlands pushed itself further into the mire yesterday when its opposition parties refused to back an austerity budget which the government collapsed over earlier in the week. That leaves the prospect of the Dutch failing to present the EU with a budget plan by an April 30 deadline and, more seriously, a period of policy paralysis stretching to elections which will not be held until September.
That vote is also quite likely to usher in an administration opposed to the austerity drive, a theme that is gathering pace within the euro zone, with socialist Francois Hollande, a warm favourite to take the French presidency next month, staking out similar ground and also suggesting the ECB should adopt pro-growth policies.
However, if there is any shift away from debt cutting – and as the IMF says, that is eminently sensible given many of these countries will drive themselves further into recession which would likely add to debt piles – it will be marginal. German opposition and the bond market will only allow a small shift in emphasis. The lessons are already there for all to see. Italy pushed back its balanced budget goal by a year, a small shift, and investors were not alarmed. Spain substantially cranked up its 2012 deficit target and has been slaughtered by the bond market ever since, to the point where many now expect it to need a bailout.
Euro zone goes Dutch
So the euro zone debt crisis morphs again and there is a hint of schadenfreude about the Dutch, who lectured and hectored the Greeks, now falling into the same mire.
The Dutch premier, Mark Rutte, will probably try to cobble together an unholy alliance in parliament in order to meet an April 30 EU deadline for it to present budget plans for the next year. But with elections not until late June at the earliest, there will be an unnerving period of vacuum for the markets and no guarantee that opposition parties will play ball and allow a budget to be put together.
Given all that, today’s Dutch bond auction, not normally a cause for alarm or excitement, is thrown into sharp relief. Expect yields to spiral although the small amount on offer means the paper will be sold. Italy is selling zero-coupon and inflation-linked bonds while Spain, which remains front and centre despite the Netherlands’ travails, will probably see borrowing costs double when it sells up to 2 billion euros of 3- and 6-month treasury bills. Spanish 10-year yields poked above the pivotal 6 percent level again yesterday as the Dutch government collapse rocked markets. The Bank of Spain confirmed on Monday that a new recession has taken hold.
That brings us neatly to one of the building themes – a backlash against rapid, frontloaded austerity. It started with the IMF/G20 over the weekend where the call went out that Europe should not cut so fast that it drives itself deeper into downturn, which would actually make debt much harder to cut since government revenues would shrink. If socialist Francois Hollande wins the French presidency, he will attempt to balance the budget a little slower than Sarkozy (though the difference between the two of them is less marked than the rhetoric suggests), Italy has pushed back its deadline to get the budget deficit to zero and the Dutch could well end up with a new government that rejects austerity given the country is also in recession and looking at the state of opinion polls. Spain, of course, has already binned its original 2012 deficit target in favour of something looser, though still exacting.
So is there a shift afoot? Two things to note here. First, the Spanish example. It has been punished by the bond market since it adjusted its deficit sights, showing no country can loosen policy more than the markets will allow (which is not much). Also on that front, ratings agency Moody’s said last night that the events in the Hague were “credit negative”. It kept the outlook on its AAA rating stable for now but said any signs of fiscal wavering would make it think again. If the Netherlands was stripped of its AAA rating, there would only be four top-rated members of the euro zone left. Secondly, Berlin has little sympathy for the growth over austerity argument and it is the one that foots the bills although if yesterday’s PMIs were anything to go by even Germany may yet succumb to recession, which could change the terms of the debate there.
Does the success of parties out of the mainstream mean the political class have lost their electorates? If that’s true, then we really are in an unpredictable new world though there has been little or no sign of social unrest yet.
The other theme to ponder is the EU fiscal pact which should not be underplayed since it will in the end commit all euro zone countries to manageable debt levels, after which, who knows, even Berlin might consider the option of common euro zone bonds which would go a long way to draw a line under the crisis. Ergo, it would be disastrous if that edifice began to crumble before it was even topped out. It only requires 12 of 17 euro zone members to ratify it to come into force which looked like a certainty. But Wilders’ populist Dutch party, which toppled the government, will now campaign against the pact, the Irish will hold a referendum on it before the month is out and Hollande has pledged to renegotiate aspects of it. It will probably be fine but there is greater uncertainty surrounding the compact now.
Roubini takes on the ECB
It was fun to watch. Nouriel Roubini, NYU economist and crisis personality, was one of just five carefully selected individuals at a large gathering in the International Monetary Fund HQ1 building’s towering atrium who actually got to ask questions of the policymakers on stage.
Roubini was characteristically biting in his critique of conventional orthodoxy, singling out the European Central Bank for not having done enough to stem the euro zone’s two-year financial crisis. He challenged the notion that the ECB is powerless to boost growth further, suggesting — to the clear discomfort of some policymakers in the room — that measures to weaken the currency could provide a badly-needed boost to exports:
I saw that on the panel there are four central bankers and the panel is about fiscal policy and sovereign debt. So the natural question is then to think maybe about what could be the contribution of central banks in resolving sovereign debt issues. Now, one simple answer would be to just monetize very large budget deficits and I understand why a central bank would say that’s a no-no.
But there’s a more subtle argument and it’s the following one: we know that while fiscal austerity is necessary, in the short-run, as even Christine Lagarde said and the IMF’s work suggests, that has a net recessionary effect on the economy. You’re raising taxes, you’re reducing transfer payments, you’re reducing government spending, so you’re reducing disposable income, you’re reducing aggregate demand. It makes the recession worse and you can get a vicious circle. Not only do you have deleveraging of the public sector but the raising of taxes and cutting of transfer payments induces also deleveraging of the private sector.
So if domestic demand is going to be anemic and weak in this fiscal adjustment because of private and public sector deleveraging you need net exports to improve to restore growth. That’s what happened in emerging market crises. But in order to have an improvement in net exports you need a weaker currency and a much more easy monetary policy to help induce that nominal and real depreciation that is not occurring right now in the euro zone. That’s one of the reasons why we’re getting a recession that’s even more severe. So, can’t we think of monetary policy as helping to induce the change in relative prices that’s necessary to have a restoration of growth if domestic demand is weak through net export improvements?
Roubini was not alone in his critique either, with the ECB coming under pressure from the IMF itself to lower rates further.
ECB Vice President Vítor Constâncio responded by stressing the institution’s price stability mandate as well as the difficulties of synchronizing policy for a group of nations growing at different speeds:
We have only one monetary policy for the average of the euro area. Headline inflation is now at 2.7 (percent). We anticipate, and we have reasons to trust the forecast that inflation in the euro area will be below 2 at the beginning of next year. Nevertheless it’s about 2. Even if you consider core inflation, it’s now at 1.6 – so it’s clearly not in any way a deflation risk. And this would be the reason for us to have a different monetary policy than the one we have now, because that would be directly connected with our mandate regarding price stability in both directions. But that’s not the case right now.
So your implicit view, or recommendation if I may draw that from your question, really would fit much better, even appropriately, with the mandate of the Fed but it’s not what we have in the ECB.
Nevertheless we are doing a lot in view of the situation that inflation expectations are very firmly anchored. That has allowed us to do lots of things. We rely and trust that in the present situation with a weak economy we can be sure of complying with our primary objective so we can do other things and we have done that – but not what you hinted at.
Bank of France Governor Christian Noyer, who was hosting and moderating the event, had spoken about that very same subject earlier during the panel discussion. Like Constâncio, he argued markets should not expect central banks to shoulder too great a burden:
A curate’s egg — good in parts
An action-packed weekend with both good and bad news for the euro zone, which may — net — leave its prospects little clearer.
Item 1: The IMF came up with $430 billion in new firepower to contain the euro zone-led world economic crisis, although some of the money will only be delivered by the BRICS once they have more sway at the Fund. Nonetheless, the figure at least matches expectations and could give markets pause for thought. The official line is that it is for non-euro countries caught up in the maelstrom but no one really believes that. If a Spain is teetering, IMF funds will be there. Together with the 500 billion euros rescue fund set up by the euro zone, there is still barely enough to ringfence both Italy and Spain if it came to it. But will it come to it?
Item 2: Socialist Francois Hollande came out top in the first round of the French presidential election and is now a warm favourite to win. Some fear that could weaken the Franco-German motor which must be humming smoothly if further crisis-fighting measures are to be convincing. Others say he is essentially a centrist who, either way, will be constrained by the realities of the euro zone situation. Domestically, his focus on tax rises over spending cuts and a slower timetable for cuts could drive up French borrowing costs. Attempts by Hollande and President Nicola Sarkozy to woo the substantial votes that went to the far right and far left could lead to some nerve-jangling campaigning messages for the markets to swallow in the run-up to the May 6 second round.
Item 3: The left-field event of the weekend was the collapse of the Dutch government over budget plans. The hawkish Dutch could now delay ratifying the EU’s new fiscal pact. Finance minister De Jager, a hardliner, promises to try and cobble together enough support in parliament for a tough budget but there is absolutely no certainty he will succeed. The standoff raises the prospect of a rating cut and an even smaller band of top-rated euro zone members. Early elections, and a period of limbo, are quite likely – a negative for the euro zone which could well balance out the progress made at the IMF. And polls suggest popular support for austerity is waning in even this “core” euro zone member.
The euro is on the back foot, getting limited support from the IMF deal, with looming Italian and Dutch debt auctions casting a long shadow. Safe haven German Bund futures are up at the open, French bond futures are down, which tells you something. Dutch debt will doubtless come under pressure. The main focus remains on Spain and Italy with the latter trying to sell a variety of debt through the week against an unfavourable backdrop. Concerns about Spain in particular are well justified but it is not yet close to the precipice. The banks are at the heart of the country’s problems and are carrying the biggest burden of bad loans since 1994. They will almost certainly need more capital at some point. On the other hand, the central bank points out that thanks to the ECB’s three-year money offer the banks have loaded up on cash to the extent that their funding needs are covered for this year, and maybe next too. Add to that the fact that Spain has shifted half its government debt issuance for 2012 in the first third of the year and it is clear it has some time to turn around market sentiment, which soured sharply when Madrid reneged on an agreed deficit target back in March.
The European Central Bank remains the key player. Weekly bond-buying data later on Monday are likely to show it remained inactive last week but with Spanish 10-year yields back above six percent, it’s a live issue again. Given the stiff opposition from Bundesbank chief Weidmann and others, who are actually pushing for an exit strategy from extraordinary measures, it is likely that things would have to get a helluva lot worse before the ECB would return to the fray.
IMF crisis funds: Why nobody really cares
With reporting from Steven C. Johnson and Nick Olivari
A lot of time and money is spent on high-profile multilateral gatherings like this weekend’s International Monetary Fund meeting in Washington. The central story this time is the Fund’s effort to raise more funds (no pun intended), which appears to have been successful as G20 nations committed more than $430 billion in new funds.
French Finance Minister François Baroin, speaking to reporters at a press briefing on the sidelines of the IMF meeting, greeted the news with optimism:
Clearly, the reinforcement of the IMF with more than $400 billion in new resources and its effects on confidence will contribute to financial stability in the euro zone.
Except that for investors, the main worry is the continued ability of Spain and Italy to keep funding their debts as borrowing costs rise. The IMF’s new so-called firewall is of little consequence to that immediate chain of events, although it does provide some marginal reassurance.
Robert Tipp, chief investment strategist at Prudential Fixed Income, says:
Euro zone hopes for funds from the Fund
Focus for the euro zone is firmly on Washington with G20 policymakers gathering ahead of the IMF spring meeting. The Fund is seeking an extra $400 billion-plus in crisis-fighting funds which, tallied with the $500 billion euro zone rescue fund about to be established, adds up to a meaningful firewall for the markets to ponder before they consider pushing Spain and Italy to the edge.
But as many sage minds are saying – U.S. Treasury Secretary Timothy Geithner among them – a firewall does not solve the root problems of the euro zone debt crisis. As our very own Alan Wheatley puts it, “It is not obvious why a stronger firewall should encourage anyone to enter a burning house”. Nonetheless, Reuters polling yesterday ascribed only a 25% and 13% chance respectively to Spain and Italy needing an international bailout.
If the IMF falls short, given the jittery mood in financial markets, that could be cue for a further sell-off. The IMF has pledges of $320 billion so far. The Chinese and British have yet to show their hands and the BRICS led by Brazil are demanding more power at the Fund before handing over extra cash. German Finance Minister Wolfgang Schaeuble told us earlier in the week that conflating those two issues was not acceptable so there is potential for a rift. The U.S. and Canada have already said they will provide no more funding. Finance ministers and central bankers from the Group of 20 advanced and emerging economies had dinner on Thursday night, ahead of a longer session on Friday.
Concerns about Spain in particular are well justified but it is not yet close to the precipice. The banks are at the heart of the country’s problems and data this week showed they are carrying the biggest burden of bad loans since 1994. They will almost certainly need more capital at some point. On the other hand, the central bank pointed out yesterday that thanks to the ECB’s three-year money offer, Spain’s banks have their funding needs covered for this year, and maybe next too. Add to that the fact that Spain has shifted half its government debt issuance for 2012 in the first third of the year and it is clear it has some time to turn around market sentiment, which soured sharply when Madrid reneged on an agreed deficit target back in March.
In the end, having lost confidence, Spain will have to do something to regain it. A strong agreement with its regions on where to cut spending might help. Ministers have met regional chiefs this week and a deal could be announced today. There is a weekly cabinet meeting today which could spell out health and education cuts, which are supposed to amount to 10 billion euros.
If the markets are onside, everything is easier. Italy showed this week that deficit targets can be loosened slightly without prompting an investor strike if they believe the direction of travel is sustainable. Spanish officials admit the communication surrounding the changed deficit target was “sub-optimal”.
Spanish Bond; a licence to kill?
Back to the familiar grist of a Spanish bond auction today. This one has real power to move global markets as it offers up a 10-year bond for only the second time this year. Because of the ECB’s three-year money glut and the general point that uncertainty rises the longer you stretch the timeframe, shorter-term paper has been a much easier sell.
10-year yields broke above the portentous 6 percent level for the first time since late November earlier this week though they have since ducked back down.
Madrid is looking to sell up to 2.5 billion euros of 2- and 10-year bonds – a relatively small amount which should attract the requisite demand. But yields will climb. The last 10-year auction went at 5.4 percent. On the secondary market those yields are now around 5.8.
Given markets are positioned for a solid sale, there is clear downside risk if it doesn’t happen.
One potential problem is that the big buyers of Spanish and Italian bonds have been domestic banks, which are not in the rudest of health and would be even more exposed if sovereign yields head yet higher. The IMF said yesterday it expected Italian banks to buy 223 billion euros in domestic government bonds this year, with Spanish banks buying 135 billion. The IMF also warned that Europe’s deleveraging banks will shrink their assets by $2.6 trillion over the next two years, further starving the real economy of credit.
France will sell up to 8 billion euros of debt, including new 2-year bonds and up to 3 billion euros of inflation-linked paper. The auctions are expected to go smoothly, with markets apparently sanguine about the first round of presidential elections on Sunday. The second round, which polls suggest will anoint socialist Francois Hollande, who is intent on tinkering with some of the EU’s crisis policies, could be a different matter.
Focus starts to switch to Washington where G20 policymakers are starting to gather ahead of the IMF spring meeting. A deal on finding $400 billion plus of new crisis-fighting funds for the IMF appears to be coming together. As of last night, the Fund said it had got $320 billion in commitments so far. Add that to the new $500 billion euro zone rescue fund and it’s possible that market sentiment will start to shift. But, as the United States and Canada are pointing out, a firewall, no matter how big, does not solve the root problems of the crisis.
