MacroScope

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.

Risk of contagion if Greece exits euro: WestLB

Ana Nicolaci da Costa

May 11, 2012 13:14 EDT

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.

Initially you have got to assume that spreads would become even more dislocated. As you are moving out and down the credit curve the ones with the weakest credit ratings will likely suffer worst, at least initially, because we are moving clearly into the world of the unknown and that’s precisely what the market doesn’t like.

The Greek elections have left a political vacuum that is raising speculation that the country may eventually exit the euro. Last Sunday, Greek voters punished mainstream parties that supported harsh austerity in exchange for international bailout cash. That left the Greek parliament with a jumble of minority parties that have been unable to form a government.

The leaders of Greece’s once-dominant conservative and socialist parties made a push on Friday to avert new elections and prevent a victory by a radical leftist who has promised to tear up its international bailout deal.

Inability to implement the reforms set out by international lenders amid this political void could compromise the country’s life-support bailout money and lead to a default. This could make the country’s membership of the euro increasingly unsustainable, even though those very reforms risked choking growth further in an economy suffering its fifth year of recession.

Even Germany, the key driver of growth in the euro zone, might eventually be threatened by worsening financial and economic conditions around it. And what of the bullish German Bund market which seems to know no bounds? Davies again:

Euro election fever

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.

 While an Hollande victory looks priced in, Greece still has some power to shock the euro zone.

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. However, the threat of contagion, while still alive, has shrunk. 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 to be 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 diminished. The caveat to that is, if it has to be cut some slack by the EU and IMF, Portugal and Ireland would presumably demand the same and then the whole austerity edifice starts to look wobbly again.

Despite the much vaunted growth strategy, the focus remains on structural reforms (which will take years to bear fruit) plus reconfiguring of some EU funds and a beefed up European Investment Bank. It will help, or at least can’t hurt, but what’s being discussed so far does not look like anything like a game changer, breaking the spiral of debt-cutting  deepening economic downturns which in turn will make it yet harder to cut debt.

And those who really count — Merkel and Draghi at the top of the list — insist the austerity drive must not be dimmed. The markets would probably respond well to growth measures which did not undermine debt reduction. But that’s some trick.

Spotlight back on Spain

After a May Day holiday lull, the euro zone roars back into life with Spain facing a game of chicken with the bond market as it auctions three- and five-year bonds and the ECB holding its monthly policy meeting in Barcelona, which lends it a certain poignancy.

Spanish yields will rise sharply compared with the previous equivalent sale and the auction is the first since S&P’s two-notch downgrade of Spain’s credit rating last week. Spanish banks, flush with three-year cash despite their horrendous bad loans problem, continued to load up on Spanish government debt in March while international investors backed off. Whether they will continue to do so is a very open question.

Three- and five-year yields on the secondary market are more than a percentage point higher than when this maturity was last sold earlier in the year. But 2.5 billion euros is a modest amount to shift and Spain has already sold half its debt issuance target for the year in the first four months.

France will also hold a bond auction, three days before its presidential election run-off. Mario Draghi pulled a surprise rabbit out of his hat last week when he added his voice to calls for a European growth strategy. With no policy change in the offing from Barcelona anything he says about that will be closely scrutinized although it already seems that he and his colleagues don’t envisage the ECB doing much to help beyond keeping policy loose. What is being talked about is some extra lending power for the European Investment Bank and some reallocation of existing EU funds, along with much-heralded structural reforms. That may help a bit but it’s nothing like enough to turn the euro zone economy around. With monetary policy already ultra-loose, that would require serious fiscal stimulus.

Euro zone leaders, led by Merkel and Schaeuble, have made it quite clear they won’t tolerate any let-up in the austerity drive to cut debt. Nor are the markets likely to accept a big shift on that front.

It seems pretty clear that things would have to get a lot worse for the ECB to resume its bond-buying programme, let alone launch a third round of three-year money creation, even though it will witness the pain in Spain first hand.

In fact, its harder core members may be more focused on 6 percent-plus wage demands in Germany which the powerful unions are threatening to strike over. Having said that, the latest survey evidence suggests the euro zone economy is resolutely heading south with the pain particularly acute in Spain and Italy.

Europe in recession – an interactive map

Scott Barber

Apr 30, 2012 06:49 EDT

Spain has become the latest European country to slip into recession joining the Belgium, Cyprus, The Czech Republic, Denmark, Greece, Italy, The Netherlands, Ireland, Portugal, Slovenia and the United Kingdom.

Click here to view an interactive map.

*Updated to include Romania and Bulgaria

Euro zone: Steps forward, steps back

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.

Plenty of grist for follow-up today with S&P analysts holding an afternoon teleconference and Spanish data on retail sales, unemployment and inflation all due this morning  – none of which is likely to paint a pretty picture.

Maybe the biggest setpiece is the Italian bond auction of up to 6.25 billion euros of five- and 10-year bonds and two other niche issues. 10-year yields are expected to leapfrog 5.5 percent at the auction – up more than half a percentage point from the last such sale a month ago; no surprise given where the secondary market now is. But at that return, demand should be solid. Longer-term paper is often trickier to sell, given the greater uncertainty built in to the timeframe, and generally requires more foreign buying. The Italian treasury has put a wide target range of 3.75-6.25 billion euros on the sale to reflect that.

With French and Greek elections looming, the ECB apparently sitting on its hands, the euro zone slipping back into recession and Spanish and French debt to be sold next week, it doesn’t look like there’s going to be any let-up.

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.

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

Pedro da Costa

Apr 20, 2012 16:35 EDT

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: