Not for the faint-hearted
With Spain’s banking system looking ever more parlous and the Damoclean Sword of Greek elections hanging over the financial markets, next week is not going to be for the faint-hearted.
Stock markets have endured another volatile week, rising early on before falling sharply just before the EU summit, then rising the day after – all this when very little changed on the euro zone landscape. Increasingly, the downward moves are sharper than the upward ones and there is little prospect of things settling before the June 17 Greek elections. It seems everyone is so nervous that if they are sitting on a day of gains, they cash them in double-quick.
Page one of the crisis management manual says get all the bad news out quickly. The handling of troubled Spanish lender Bankia has been an abject failure in that respect. First, the government said it would require about 9 billion euros to shore up, a few days on they are looking at 20 billion. One proposal doing the rounds is to create one nationalized bank out of a number of failed lenders. The big question, to borrow heavily from Louis XV, is: Apres Bankia la deluge?
It looks increasingly likely that Madrid will have to take a bailout for its banking system despite its protestations to the contrary. The money is there in euro zone rescue funds to cope but one of Spain’s only trump cards – that it had issued well over half the debt it needs to this year – may have disappeared after the government revealed that the publicly stated figure for the autonomous regions’ maturing debt – 8 billion euros for this year — is in fact more like 36 billion.
If Spain looked in real trouble (Greek contagion could play a part here) that might be the tipping point that persuades the euro zone to take more dramatic action. With German opposition to common euro zone bonds unbudgeable for now, a lot of the onus would fall on the ECB which, while deeply reticent to revive its bond-buying programme, could well be pushed into a third round of three-year money creation at some point. And if there was any sign of a bank run, plans for a deposit guarantee fund could have to be dusted off very quickly. Would that do the trick?
If Spain can be dealt with via existing bailout funds – if it comes to that – it may well be that, as it was last year, it would take Italy to come seriously into the firing line to push the ECB into overdrive. Italy will sell debt of varying denominations on Monday, Tuesday and Wednesday, giving plenty of scope for jitters. And there’s plenty else besides to keep longer-term investors on the sidelines.
Ireland holds its referendum on the new EU fiscal treaty on Thursday with the result expected the day after. Polls suggest it will pass. If it didn’t, the country would have a serious headache given it is under a bailout programme but would have rejected the debt rules the bloc is being asked to meet. While the treaty needs the approval of only 12 of the 17 euro zone countries to be ratified, an Irish rejection would be another scab for markets to pick away at.
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
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:
debt relief by more debt added faster…faster..faster.faster…
the math is compelling.
the greeks must default…default..default.default…
printing is the world’s only current option. if, and only if, the major currencies agree to unified manipulation of currencies, and stick to it, can the pain inflicted by fiat foolishness be gentled enough to allow the real people to be ok.
p.s. the printers must agree to a fixed ‘flow’, but that’s another story.
Europe in recession – an interactive map
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
Thanks for comments – Will update with Romania and Bulgaria
The euro zone today – strikes, reform and recession
The euro zone economy looks to have contracted at a faster pace in March, according to the latest purchasing managers’ data, hours after ECB President Mario Draghi declared the worst of the debt crisis to be over. A mild recession appears to be in prospect with the probable exception of Germany.
The two aren’t mutually exclusive. Even if the existential threat to the currency bloc has passed, many of its members face years of economic hardship yet. With China’s equivalent report also coming in weak, the short-term signs are not auspicous.
Italy’s largest trade union has called a strike for the near future over Prime Minister Mario Monti’s labour reforms which have been rehardened to make it easier to fire not just workers in new jobs but right across the labour force. The prime minister says he won’t negotiate further given he has the support of other unions as well as employers groups. However, there is room for “fine tuning” today and tomorrow. The CGIL union has called for an eight-hour general strike with more to follow.
This is big stuff. A number of key factors have helped move the euro zone debt crisis on from critical to chronic; top of the list was the ECB’s creation of a trillion euros of three-year money but not far behind came the elevation of Monti and the hope invested in him that he can turn the Italian economy around. If the euro zone’s third largest economy fell over, the currency bloc really would be on the skids.
Monti must convince markets – which continue to give him the benefit of the doubt for now – that he can raise Italy’s trend growth rate if its 120 percent of GDP debt pile is ever to be eaten into. If faith in the technocrat premier wanes, it could have a significant effect on currently benign investor sentiment towards the euro zone.
Today, bailed out Portugal also faces a general strike protesting at austerity measures which the government is doing its best to stick to, without much prospect that it will turn the economy around. Data on Wednesday, showed Portugal’s core public deficit nearly tripled in the first two months of 2012, showing a deepening economic slump is denting tax collection and stoking concerns it will follow Greece in requiring more rescue funds. The difference is there is much greater euro zone goodwill towards Lisbon, so those funds will be provided without much grumbling.
Ireland, the country that seems to have a chance of riding the austerity wave successfully, produces Q4 GDP data which will show whether the government met its 1 percent growth target next year, while Germany continues to look like an economy on a different planet to its currency peers. It expects to balance its budget for the first time in more than 40 years in 2016 thanks to strong growth and full tax coffers.
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.
If Spain sells at the top end of its target range today, it will have shifted nearly 45 percent of its annual issuance in less than a third of the year. Italy is also making great strides (it shifted six billion euros of debt yesterday at markedly lower yield) – a factor that is taking further stress out of the euro zone debt crisis, at least in the short-term.
Rewind to the beginning of the year and everybody was fretting about Italy facing a mountain of refinancing (with the same true of Spain to a lesser extent) and now it looks like no more than a small bump in the road thanks to the ECB’s largesse.
Markets remain (dread phrase) “risk on” mode. German Bund futures have shed another half point although European stocks look flatter after a good run so far this week. France also comes to the market with a bond sale today and should benefit from the same prevailing market conditions.
After the Greek parliament formally approved the terms attached to a second bailout on Wednesday, Portugal has been firmly identified as the next shoe to drop although the EU’s economy chief, Olli Rehn, said late yesterday that Lisbon was on track with its bailout programme. While Italian and Spanish borrowing costs have tumbled, largely thanks to the ECB, Portugal has failed to hitch on to that ride. However, a second package for Lisbon would probably need to be in the region of 30 billion euros, not a sum to stretch the euro zone’s resources.
What the euro crisis is not
With Southern Europe getting so much of the blame for the continent’s financial crisis, it is refreshing to see someone highlight the other side of the coin. That’s just what Joshua Rosner, managing director of Graham Fisher & Co., did in testimony on Thursday. Asked to discuss the potential risk to U.S. taxpayers of the ongoing political battle over a frayed monetary union, Fisher began his remarks by debunking the reigning narratives being used to describe the crisis:
To fully assess the risks to the United States and our proper role in the euro zone crisis it must first be clear what the crisis is and is not. It is not a bailout of the populations of the weaker European economies such as Greece, Ireland, Portugal, Italy, Spain, Hungary or Belgium. After all, the populations of those countries are being forced to give up portions of their sovereignty in the name of austerity toward a fiscal union.
Rather, I would contend, it is a bailout of banks in the core countries of Europe, of their stockholders and creditors who, failing to gain sufficient access capital markets, would need to be recapitalized by their host country governments. It is a transfer of losses from banks and corporations onto the backs of ordinary people without requiring any recognition of losses by those banks whose risk management and lending practices created the problem. It is as much a tale of over lending as it is of over borrowing and, just as nobody should feel undue sympathy for those who miscalculated the amount of debt they could service, nobody should feel for those who miscalculated their lending risks.
Banking on a Portuguese bailout?
Reuters polls of economists over the last few weeks have come up with some pretty firm conclusions about both Ireland and Portugal needing a bailout from the European Union.
Portuguese 10-year government bond yields have hovered stubbornly above 7 percent since the Irish bailout announcement, hitting a euro-lifetime high and giving ammunition to those who say Lisbon will be forced into a bailout.
And of those who hold that view, it’s clear that bank economists have been most vocal in expecting Ireland and Portugal to seek outside help.
Take last week’s poll in which economists said Portugal would follow Ireland in applying for EU funds. Bank-based economists who expected a Portuguese bailout outnumbered those who didn’t almost three-to-one. For non-bank economists – those working at research houses, brokers and wealth management firms – the margin was only two-to-one.
This division was even more marked in the Irish bailout poll we ran three weeks ago. Bank-based economists expecting an Irish bailout outnumbered those who didn’t more than two-to-one. Our sample of non-bank economists were split almost evenly on the subject.
Interestingly, market makers and primary dealers – or banks mandated by government debt agencies to deal their new government bond issues – were staunchest in expecting Irish and Portuguese bailouts.
Of the seven economists polled by Reuters who work for primary dealers of Portuguese debt, six said Lisbon would need to apply for a bailout. For analysts representing primary dealers of Irish debt, four out of five said a bailout was imminent.
Europe’s over-achievers and their fall from grace
Ireland’s fall from grace has been rapid and far worse than that of its counterparts, even Greece. But life in the euro zone has still been one of profound growth, as it has for most of the other peripheral economies.
Take a look first at the progress of PIGS (Portugal, Ireland, Greece and Spain) GDP since 2007 when the global financial crisis took hold. In straight comparisons (ie, rebased to the same point) Ireland is far and away the biggest loser. Portugal is basically where it was.
But now take the rebasing back to roughly the time that the euro zone came together. First, it shows that Ireland’s fall is from a very high place. The decade has still been one of profound improvement in cumulative GDP even with the last few years’ misery. But it is front loaded.
Perhaps most interesting, however, is what the second graph (courtesy Reuters’ Scott Barber) says about the PIGS and the euro experiment. Despite major financial and market crises, Greece, Spain and Ireland have all seen their economies accumulate at a higher rate than the euro zone average. Only Portugal has been below average — a perennial slow grower.
Could any of this outperformance have been attained outside the euro zone? Probably not. But the question now is whether the current troubles are going to wipe out everything that has been achieved.
ECB stuck feeding southern Europe’s cash addiction
Commercial banks in southern Europe are increasingly addicted to cheap central bank money after dealers shut them out of money markets. Due to this dependency, the European Central Bank will have little option but to keep offering banks cold hard cash for almost nothing – currently it prices its loans at 1.0 percent.
Economic growth in the euro-zone core has been robust lately, but southern Europe has been hit hard on several fronts recently and is falling badly behind. First, the sovereign debt crisis hit Greece and other southern periphery countries, then bank stress tests showed 6 out of 7 failing banks were in Spain or Greece, and then the region posted only tepid economic growth.
Bank borrowing from the ECB shows increasing strains in southern euro-zone’s financial sector while banks elsewhere are getting back on their feet, but the fear of contagion from country to country will keep the ECB on its toes. Banks in Greece borrowed twice as much last month as they did in July 2009, even though outstanding central bank lending fell 18 percent over the same time. Banks in Portugal borrowed five times as much in July 2010 as they did a year earlier, and borrowing also rose in Spain and Italy.
“The full-allotment fixed-rate repos will stay well into next year,” said Michala Marcussen, Societe General chief economist. “Beyond the first quarter of next year, the overall economic environment will be the key determinant in how much longer it gets carried. In all likelihood it could get carried further ahead.”
The ECB tried to reintroduce limits to borrowing in April but was forced into a U-turn by the sovereign debt crisis, returning to its full allotment policy in May. Fourth-quarter plans are due to be revealed in September, with markets expecting full allotment to continue.
Among the ECB’s 22 Governing Council members, Cyprus’s Athanasios Orphanides and Ireland’s Patrick Honohan have indicated the unlimited funding should continue, and on Friday Germany’s Axel Weber made clear exit discussions should not resume until early next year. His dovish tone got analysts’ attention.
