MacroScope

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.

Aside from the auction, there is an important looking meeting between Rajoy and the president of the powerful Catalonia region, which has sought government help with its debt. A combination of spiraling regional debts, deepening recession and stricken banks means Madrid is highly unlikely to dig itself out of this hole alone. There will be a political temptation to wait until regional elections in late October are out of the way but that looks a stretch. More likely is the wheels start moving after the government unveils its 2013 budget and a new round of structural reforms at the end of September, when detailed stress tests of the country’s banks will also be published.

We know that China is watching events closely although it has never followed through on pledges to buy more euro zone bonds. Today, Chinese Premier Wen Jiabao will meet European Commission President Jose Manuel Barroso and Herman Van Rompuy, president of the European Council in Brussels. Trade issues and disputes will be to the fore but the euro zone crisis is bound to figure too.

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.

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.

After some perplexingly negative initial market reaction to the Draghi gambit everything turned around. European stocks leapt nearly 2.5 percent yesterday and Asian shares are set to bank their biggest daily gain in six weeks. Italian and Spanish borrowing costs have fallen markedly.

The fact that the ECB has set no limit on how many bonds it might buy marks this scheme out as very different to its predecessor but we’ve seen many false dawns before so it behoves us to keep an eye on what might prevent ECB President Mario Draghi drawing a line under nearly three years of debt crisis.

       1. Could Bundesbank chief Jens Weidmann, who remains strongly opposed, quit as his predecessor did last year? Very unlikely for now though there could be a later confrontation, on which more below. It was notable how many of Angela Merkel’s political lieutenants were deployed in public to back Draghi yesterday, although the German press have taken an altogether more negative view which could inflame German public opinion.

Some say the European Central Bank will cut rates. Some say they won’t.

The odds that either prediction could turn out to be true on Thursday are more even than since Reuters first began polling on ECB rates in 1999.

Even during the highly volatile, uncertain time that followed the collapse of Lehman Brothers, Reuters polls of ECB watchers always resulted in a clear majority of economists leaning toward one particular rate cut size.

In the Reuters poll taken last week, 36 of 70 economists expected the ECB to leave the refi rate at 0.75 percent, while almost as many, 34, said it would cut it to 0.50 percent.

Having not enjoyed a summer lull for a good few years, we might as well take advantage of this one which appears set to last for another couple of weeks yet (famous last words).

European Central Bank President Mario Draghi’s pledge to do whatever it takes to save the euro zone continues to underpin markets who view a litany of grim economic evidence as increasing the likelihood of further central bank action, not just from Europe but China and the United States too, thereby leaving them somewhat becalmed. (Remember the Greenspan put?)

The ECB chief’s intervention remains strictly in the realms of the rhetorical for now. The proof will come in September at the earliest – an ECB policy meeting in the first week is likely to set out the parameters as to how it might act to lower Spanish and Italian borrowing costs, a week later the German constitutional court rules on the viability of the euro zone’s permanent rescue fund, then euro zone finance ministers gather in Cyprus for a key meeting. Also in September, the troika of Greek lenders will return to decide whether Athens has done enough to secure its next bailout tranche.

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.

Financial markets on Thursday were starkly disappointed with the European Central Bank and its president, Mario Draghi. He had promised recently to do everything in his power to save the euro and yet announced no new bond-buying at the central bank’s latest meeting. Riskier assets sold off and safe-haven securities benefitted.

But Francesco Garzarelli of Goldman Sachs, Draghi’s former employer, has a different take on the matter:

We see a material change in the central bank’s approach to the crisis, and a coherent interplay between fiscal and monetary policy. The underwhelming part of today’s announcements lies in the lack of details on the asset purchases and other measures to support the private sector. But it appears that these will have more structure around them than the SMP (Securities Markets Program).

Euro zone finance ministers meet later today to try and put flesh on the bones of the EU summit agreement 10 days ago. The trouble is there probably won’t be enough meat for markets which failed to rally significantly after the summit deal and are now unnerved by fresh signs of global slowdown.
Friday’s weak U.S. jobs report is the latest evidence to rattle investors so there is unlikely to be any let-up.

Spanish 10-year yields are back above seven percent. Madrid is fortunate not to face a heavy debt issuance month but August is a bit more demanding so time is short to turn things around. Italy’s Mario Monti said on Sunday the euro zone ministers must act now to lower borrowing costs and Spanish Prime Minister Mariano Rajoy more dramatically said the credibility of the entire European project rests here. He continues to do his bit, pledging on Saturday to produce further deficit-cutting measures, probably on Wednesday. They could include a VAT hike and cuts to public sector benefits.

The Eurogroup is unlikely to dramatically change the terms of trade. It has a lot on its agenda – the proposed bailout of Spanish banks of up to 100 billion euros, a much smaller bailout of Cyprus as well as firming up the summit agreement that the euro zone’s rescue fund should be tasked with intervening on the bond market to bring borrowing costs down and, once a cross-border banking supervision structure is in place (another highly ambitious plan which is supposed to take shape in an even more ambitious six months), to be allowed to recapitalize banks directly.

With Spanish Prime Minister Mariano Rajoy calling for a new euro zone fiscal authority to manage the bloc’s finances and send markets a signal that EU leaders mean business about defending the euro, it is clear that the push towards fiscal union, led by Germany, is gathering momentum. Germany has also conceded that Spain should get an extra year to make the spending cuts demanded of it, suggesting it is aware that the crisis is lapping at its door again.

But economic union, even if agreed (it runs contrary to generations of French political culture to relinquish that amount of national sovereignty) will take many months even years to put into practice, given the complex treaty changes that will be required.

The hope is that a strong signal of intent at the end-June EU summit will calm markets and encourage the European Central Bank to hold the fort in the meantime. The former looks like a somewhat heroic hope. On the latter? Well, the ECB has made it quite clear it wants government to sort out the mess but has also consistently proved itself to be the only institution capable of moving quickly enough when the crisis turns acute. So it will almost certainly intervene again if the bloc reaches the point of calamity, though that is more likely to take the form of an interest rate cut and a third round of three-year money creation than a serious revival of its bond-buying programme.