MacroScope

Disquiet at the ECB

A day for central bankers and maybe the hint of a row brewing within the ECB. After days of jitters, euro zone bond markets were calmed a little this week when ECB policymaker Benoit Coure said the central bank’s government bond-buying programme could be revived if Spain started teetering.

That is decidedly not what the orthodoxists in Frankfurt would have wanted to hear. They are already worried that the creation of more than a trillion euros of three-year money could be stoking future inflation and creating addicted banks and feel that the bond-buying programme crosses a red line — that the ECB should not fund governments.

We know Bundesbank chief Jens Weidmann has been leading the charge to at least talk about an exit strategy from the ECB’s extraordinary policy stance – something the top man, Mario Draghi, slapped down pretty bluntly last week — and Orphanides, the ECB man from Cyprus, was out last night saying individual central bankers should not be making any commitments about bond-buying, a clear swipe at Coure.

The new line-up at the ECB appears more collegiate and pragmatic than their predecessors, so don’t expect any flouncing out as the German duo Axel Weber and Juergen Stark did last year. But given that the ECB has been the consistent guarantor and decisive actor during the debt crisis so far, any signs of a split are not likely to do anything for markets’ nerves. Germany’s Joerg Asmussen, Dutch central banker Klaas Knot and France’s Christian Noyer are all speaking today.

The focus is already shifting to the IMF annual meeting which starts this time next week with Lagarde saying yesterday that more crisis-fighting funds were needed, though maybe not as much as had been thought as risks were receding (the Spanish will be heartened and maybe surprised to hear that!). The deal may not be done next week though and she emphasized that IMF resources would be devoted to protecting non-euro zone countries caught up in the turmoil. That may be the political message she needs to deliver to make headway.

Italy up for auction

All eyes on Italy. After paying sharply higher yields to sell one-year paper on Wednesday, it faces the altogether trickier task of selling up to five billion euros of three-year bonds. Yields are expected to jump by a full percentage point from a month ago but, as with yesterday, demand will be there and the paper should get away.

German Bunds have opened flat and European stocks are set to edge up so the recent rush for the exits has at least temporarily abated.

After yesterday’s auction result, Italian officials were  quick to point the finger at “external factors” – code for Spain. That prompted Spain’s Mariano Rajoy to hit back, demanding European leaders choose their language with more care. The message from Madrid is that the government is doing everything asked of it on the austerity and structural reform front and needs stronger backing from its peers. It’s hard to argue with that. Italian premier Mario Monti has said similar about Italy. The difference is that he did not renege on an agreed deficit target without consulting Brussels.

The pain in Spain falls mainly on…

Spanish 10-year bond yields are within a whisker of breaking above six percent for the first time since December and are dragging Italy’s up with them. The balmy days of first quarter calm are well and truly over. “Markets step up the attack”, El Pais blares from its front page this morning.

Spanish risk premiums have leapt since Prime Minister Mariano Rajoy defied Europe by unilaterally easing Madrid’s 2012 deficit target and investors seem to have lost faith again as the impact of the ECB’s massive liquidity injection begins to fade.

BUT, and there is a but, there are good reasons to believe Spain will not fall over in the way Greece and others have. One silver lining for Madrid is that it has taken advantage of the benign market conditions early in the year to clear almost half its 2012 debt issuance needs so rising secondary market yields may be less damaging than they were last year.
 
As usual, confidence is key. The ECB three-year money has not vanished. Look at the 800 billion or so euros deposited back at the ECB by banks every day and it’s clear that if sentiment improved some of that money could be put to use once again to buy Spanish and Italian bonds, though there’s no sign of that for now.
 
Markets are resolutely “risk off” although weak U.S. jobs data last week have a part to play here. European stock futures are flagging a further 0.5 percent loss following a 2.5 percent tumble on Tuesday. The most reliable euro zone barometer – the Bund future – has edged lower at the open, probably in anticipation of Germany auctioning a new 10-year bond later. Given the climate, it should be snapped up despite yields already at record lows: While Spain faces a 6 percent price to borrow for 10 years, Germany can do so for 1.6 percent.

Euro zone perspective – nowhere near out of the woods

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.

Today in the euro zone – a blizzard of bailout numbers

Brace yourself for a blizzard of numbers.

EU finance ministers gathered in Copenhagen are poised to decide precisely how much firepower their new rescue fund – to be launched mid-year – will have. A draft communiqué suggests that as of mid-2013, presuming no new bailouts have been required in the interim, the combined lending ceiling of the future ESM and existing EFSF bailout funds will be set at 700 billion euros (500 billion pledged to the ESM plus the roughly 200 billion already committed to Greek, Irish and Portuguese rescue programmes).

Up to mid-2013, if 700 billion proves to be insufficient — i.e. someone else needs bailing out — euro zone leaders will be able to bolster it with the 240 billion euros as yet unused in the EFSF, according to the draft, although German Finance Minister Wolfgang Schaeuble said last night that 800 billion should be the absolute limit.

Sorry, there’s more. Because the ESM will not have its full 500 billion euros capacity on day one – it will build up over time – the real available figure for the next year is more like 640 billion euros.
Confused? You should be.

Today in the euro zone – Bonds, strikes and firewalls

Big debt test for Italy which will sell 8 billion euros or more of longer-dated bonds. A short-term T-bill sale went okay on Wednesday but a day before, the secondary market reacted negatively to a sale of zero-coupon and inflation-linked bonds, pushing Italian yields higher.

The glut of ECB three-year money has ensured Italian and Spanish auctions have sailed out of the door so far this year but there will be no more largesse from the central bank so be on the look out for signs of that support fading. Analysts expect this sale to go well with Italian banks wading in again.

Euro zone money supply data on Wednesday showed Spanish and Italian banks stocked up on government bonds in February – and that was before the ECB’s second instalment of money creation to the tune of 500 billion euros. So bond sales should be underpinned for some time yet though it is clear that the central bank has bought policymakers time rather than solved the root problems.

Today in the euro zone – the elusive firewall

Conflicting pressures for the euro zone bond market today – a strong signal from Germany that it is willing to increase the firewall built around the currency bloc but ongoing concerns that Spain is being dragged into the mire.

Litmus tests are provided by an auction of a mixture of Italian debt worth up to four billion euros and the sale of short-term Spanish t-bills. While Spanish yields on the secondary market have come under pressure there has been no sign yet that primary sales will have any difficulty, given the more than 1 trillion euros of three-year ECB money sloshing round the financial system.

Italian Prime Minister Mario Monti and Spain’s Mariano Rajoy are both in South Korea for a nuclear summit and could well break cover.

Euro zone today – manning the defences

In euro zone terms, two themes will dominate the week: Spain and the size of the euro zone rescue fund (Italy’s labour reforms will play a supporting role).

Yesterday, Spanish Prime Minister Mariano Rajoy won a key regional election in Andalusia although not as handsomely as hoped, raising the possibility that the socialists could rule there if they find a coalition partner. The result could hamper the government’s plan to press the autonomous regions harder to cut public spending. Having ripped up the deficit target agreed with Brussels last month, Spanish borrowing costs are already on the rise. Any further sign of wobbling could be seized upon by the markets. Spain faces a general strike on Thursday and Rajoy’s administration will present its full 2012 budget on Friday.

Also at the back end of the week, EU finance ministers meet in Copenhagen with the thorny issue of how, and by how much, to increase the euro zone’s future ESM rescue fund top of the agenda, which comes into being at mid-year.

Today in the euro zone

Morning all from a fogbound London. Visibility may be down to a minimum but there is a developing view that the euro zone debt crisis, if not solved, is in remission.

Spain should follow Italy’s lead yesterday and sell short- to medium-term bonds with ease despite a tussle with the EU over what deficit level it should be aiming for next year. Madrid will sell up to 3.5 billion euros of three- and four-year paper, a lower amount than it has been pushing out so far this year, which means it should be snapped up.

There has been some disquiet in the market after Prime Minister Mariano Rajoy threw out a Brussels-agreed target of a 4.4 percent/GDP deficit this year and said he would only shoot for 5.8. His peers have subsequently hauled him back to 5.3. But any doubts over debt slippage continue to be overwhelmed by the wall of money created by the ECB which is sloshing around the financial system looking for a home.

Today in the euro zone

Top billing of the day probably goes to Germany’s Merkel and Italy’s Monti meeting in Rome, though it is quite late in the day.  The Italian premier remains the austerity poster boy, in contrast to Spain’s Rajoy who was partially let off the hook by Brussels last night for abandoning his deficit target, though he was told to split the difference between the first target and his new, looser goal.

While trying to avoid a blizzard of numbers, Spain was supposed to land a deficit of 6 percent of GDP last year and 4.4 this, en route to the main target of 3.0 percent in 2013. Rajoy’s new government announced that last year the deficit had in fact swelled to 8.5 percent of GDP and as such he would only aim for 5.8 percent this year while sticking to next year’s goal. The Eurogroup told him last night to aim for 5.3 this year, cutting some significant slack but, but by demanding more cuts than Rajoy wanted to deliver, probably avoiding serious market disquiet about Spain becoming the new Greece – forever missing its targets – and undermining the bloc’s new fiscal pact while the ink is barely dry.

Nonetheless, the net result is likely to be to drag Spain deeper into recession this year. Looking at bond yield spreads, the markets don’t smell blood yet.