MacroScope

Spanish Prime Minister Mariano Rajoy meets labour union and business leaders to discuss reforms to pensions and public institutions. After some fairly brutal cutting, Rajoy has grown more cautious. He is negotiating a new formula for calculating pension payoffs but is wary of going further for fear of sparking greater protest. And all the time, recession put the country’s debt targets further out of reach.

There’s still some pretty serious stuff on the table. Rajoy’s cabinet has proposed a “stability factor” for the pension system, which would periodically adjust pay-outs and retirement age based on economic performance, demographics and other factors. The government is also studying a major reform to public administrations that could mean numerous job cuts in the public sector at a time when unemployment is at 27 percent.

The EU has granted France, Spain and others more time to meet their deficit targets in an attempt to foster some growth. But it is also insistent the pace of structural reforms must be stepped up. The French parliament voted through labour reforms on Tuesday which will make hiring and firing somewhat easier. President Francois Hollande will hold a rare news conference having travelled to Brussels yesterday to declare he would use the leeway to boost competitiveness and growth. Details? There were none. The European Commission will spell out its recommendations at the end of the month.

Labour reform, along with public spending cuts and steps to plug a funding shortfall in France’s pension system, are among measures the European Commission is seeking from Paris in return for granting it two more years this month to bring its public deficit down to below 3 percent of national output.

One of Hollande’s problems has been the mixed messages coming out of his cabinet. Speculation is rising of an imminent cabinet reshuffle after persistent rows between Finance Minister Pierre Moscovici and junior industry minister Arnaud Montebourg. Hollande’s ratings are tumbling, as is the French economy which has slid back into recession.

With Spain content to sit on its hands for now (European Central Bank policymaker Nowotny highlighted the status quo on Sunday, saying Madrid is fully financed for the rest of the year), Greece and Italy will hold the euro zone spotlight for the next few days.

Yesterday, we reported that the EU and IMF have refused to offer any further concessions on the labour reforms they are demanding and which one party in Greece’s ruling coalition refuses to countenance. The government could just about carry a vote in parliament without the support of the Democratic Left but it would only take a handful of rebels within the New Democracy and PASOK parties to turn the tables. So we’ve got another standoff. The bill is due to go to parliament next week.

With the debt numbers clearly not adding up, more money – up to 30 billion euros –  is going to be needed, be that via lower interest rates and longer maturities on loans and/or a writedown on Greek bonds held by the ECB and euro zone governments. Athens looks set to get the extra two years it requested to make the cuts demanded of it.

Big day in Berlin with European Central Bank chief Mario Draghi entering the lion’s den of the Bundestag to explain to German lawmakers why his plan to buy sovereign euro zone bonds in potentially unlimited amounts poses no threat to the ECB’s remit and the euro zone economy.
Former ECB chief economist Juergen Stark – one of Draghi’s most trenchant critics – told us yesterday that the ECB president must present much more convincing arguments than hitherto as to why the plan would not pile enormous risks onto the ECB’s balance sheet for which European taxpayers could have to pay.

The session, which will include 10-minute introductory remarks from Draghi followed by a lengthy Q&A and then short public statements from Draghi and Bundestag President Norbert Lammert, is a rarity. The hawks in parliament will demand to know how bond-buying is remotely in line with the ECB’s mandate. The more moderate will at least want to hear what sort of conditionality the ECB wants to see before it leaps into the breach, and the backdrop is coloured by continued Bundesbank opposition to the Draghi strategy. Angela Merkel is speaking at a separate event in Berlin in, as does Wolfgang Schaeuble later in the day.

Spain will probably loom largest for the German lawmakers but Greece continues to run it a close second with suggestions growing that it will get an extra two years to make the cuts demanded of it. But even that may not be enough for the EU/IMF/ECB troika of inspectors to conclude that Athens’ debt sustainability programme is back on track. The IMF appears to believe that only a writedown of Greek bonds held by the ECB and euro zone governments will do the trick. They, predictably, are not keen.

Spanish Prime Minister Mariano Rajoy secured an overall majority in regional elections in Galicia over the weekend but in the Basque country, the nationalists were the big winners. These polls have been identified as one reason why Rajoy has held off asking for sovereign aid and Catalan elections still loom next month. Rajoy is likely to have to offer politically poisonous pension reforms in return for outside assistance.

So far, we seem to be no closer to a bailout request, which could then trigger European Central Bank intervention, and with 10-year yields having dropped more than two percentage points from a 7.5 percent peak since Mario Draghi’s vow to do whatever it takes to save the euro, one could reasonably ask why Madrid should be in a hurry. Some officials are saying Spain could quite comfortably wait until the turn of the year, leaving a prolonged period of limbo.

The fact is that if market pressure comes back on, Spain can quickly approach the euro zone’s ESM rescue fund for help and the ECB can pile in thereafter. So what has happened is that a bit of fear has been put back into investors intent on shorting the euro zone periphery to their hearts’ content; fear that wasn’t there until recently. It looks increasingly likely that Madrid would seek a precautionary credit line from the ESM, with conditions attached, which in theory could allow the ECB to buy Spanish bonds without the government actually taking money from the rescue fund. That would be a much easier sell politically.

The day before an EU summit that probably won’t come up with anything decisive in crisis management. If that sounds rather underwhelming beware. There’s an awful lot of jockeying for position over when Spain will seek sovereign help, the Greek troika talks continue to look messy with time running very short and the leaders would be very well advised to demonstrate that their longer-term plans for closer integration are not running out of puff – item one on that agenda is getting plans for step one of a banking union back on track.

We could get a decent crack at this today with a number of EU leaders, including Angela Merkel, Spain’s Mariano Rajoy and Greek premier Antonis Samaras, gathering in Bucharest for a centre-right political congress.

On the jockeying front, German Finance Minister Wolfgang Schaeuble has called for a leap forward in euro integration, particularly in terms of fiscal union with a commissioner given power over members’ budgets. That’s going to prompt some heated debate in Brussels on Thursday/Friday with France, in particular, likely to be aghast.

Some interesting flesh to pick from the bones of the IMF gathering in Tokyo. Most notably, a clutch of high-up euro zone sources in Tokyo told us that Spain could ask for aid next month at the same time as the Greek bailout package and one for Cyprus are sorted out. All roads appear to be pointing to the Nov. 12 meeting of euro zone finance ministers. However, there are other voices saying that Spain could hold off until the new year, given the fall in its borrowing costs since ECB chief Mario Draghi declared he would do whatever it takes to save the euro.

Spain can cover a fairly heavy debt redemption hump at the end of this month but given its recession is deepening, and deficit targets are likely to be missed, the refinancing crunch could fall in January. Prime Minister Mariano Rajoy remains a difficult character to read but we know the French are pressing him to jump and Italy’s Mario Monti said on Friday that a Spanish request for bond-buying help would calm the markets.
For his part, Rajoy wants to know what sort of deal he will get. As we reported last week, and El Pais followed up on, he is asking how the ECB would intervene with a preference for it to commit to achieve and maintain a certain yield spread over German Bunds.

Nearly everybody, including, crucially, Angela Merkel, has come round to the view that Greece should stay in the euro zone for now. The possible exception has been German Finance Minister Wolfgang Schaeuble but late yesterday, in Singapore, he too seemed to fall into line saying that Greece will not default and that he wanted to shut down any talk of euro zone exit.
Greek PM Antonis Samaras put his foot on the accelerator over the weekend, predicting the broad outlines of a deal on a new austerity package in time for the EU summit at the end of this week, although he appeared to be talking about the troika of EU/IMF/ECB inspectors finishing their work on the ground, rather than a new deal being sealed in full.

The IMF is ratcheting up the pressure on the euro zone again, telling it to deepen financial and fiscal ties as a matter of urgency to restore confidence in the global financial system. Despite the European Central Bank’s recent statement of intent, the Fund said the risks to financial stability had risen over the past six months and it raised its prediction of how much European banks are going to have to offload as part of a deleveraging process that has a long way to run.

An eye-watering $2.8 trillion of assets now needs to be cut over two years, which could further choke off credit to the currency bloc’s weaker members, deepen recessions and push up unemployment. Despite recent steps, the euro area is still threatened by a “downward spiral of capital flight, breakup fears and economic decline”.

Gloomy stuff and particularly noteworthy since the growing view in Europe is that on break-up fears at least, the ECB’s promise to buy sovereign bonds in unlimited amounts, once a country seeks help from the ESM rescue fund, had fundamentally turned a corner.

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.

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.

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.