MacroScope

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.

Attempts to form a Greek coalition government appear to be running into the sand with no one prepared to dance with the two mainstream parties, New Democracy and PASOK, raising the probability of a fresh round of elections with all the uncertainty that will entail. The far-left Socialist Coalition will have a stab at forming an administration today but doesn’t really have the numbers to do it.

The only plan that looks like it offers a glimmer of hope is that put forward by PASOK leader Evangelos Venizelos. He is after a “pro-European” coalition and has pledged to spread the cuts Greece has been ordered to make under its bailout programme over three years not two. If a burst of realpolitik every takes hold in Athens (and it’s worth noting that nearly all the parties say they want to stay in the euro), that could just be enough to get others on board. BUT, Venizelos would then have to go to Brussels to persuade the EU to go along with this relaxation of its targets and, on and off the record, officials lined up yesterday to say there was no prospect of that happening.
And his PASOK was the party that was most badly humiliated at Sunday’s election so it’s hard to see how it has a mandate to rule the Greeks, a majority of whom voted firmly against austerity, even it is in a broad coalition.

So new elections next month are likely which leaves a very compressed timeframe and who knows what political landscape will result second time around. The EU/IMF/ECB troika is supposed to return in June and can’t negotiate on the next bailout tranche if there is no government. In any case, Athens is supposed to find 11 billion euros of extra cuts as part of the aid programme and none of the parties are in a position to do that as things stand.

It was Bill Clinton who, after the 2000 U.S. election was thrown into turmoil by Florida’s hanging chads, said the American people had spoken but it was going to take a little time to work out what they had said.
No such dilemma in Greece. A plague on both your houses was the message for the traditional ruling parties PASOK and New Democracy, a result that makes a stable government look a remote possibility and puts a very real question mark over its bailout programme.

Today, the largest party New Democracy will try to form a coalition. Given what they’ve said, the left-wing Left Coalition which leapfrogged PASOK into second place cannot be part of a government committed to the bailout terms so it looks like the two traditionally dominant parties — two seats short of an overall majority between them — must seek support from elsewhere or face fresh elections which could well give an even more fractured result. One thing worth noting is that even the resurgent anti-bailout parties mostly say they want to stay in the euro zone so maybe there’s soom room for negotiation.

The euro has dived to a three-month low, Bund futures have posted yet another record high and European shares are down so we’re right back in fear mode.

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.

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

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.

There is a groundswell building in the euro zone that austerity drives should be tempered.

France’s Francois Hollande, favourite to take the presidency next month, said last night that  leaders across Europe were awaiting his election to back away from German-led austerity, and even ECB President Mario Draghi called yesterday for a growth pact.

He was rather opaque on how – although he was clear the European Central Bank would not be doing anything more — but his colleague Joerg Asmussen was a little more forthcoming, saying some EU structural funds could be funneled to countries in crisis to boost employment. These sort of ideas are actively part of the mix and could well be enacted at the June EU summit.

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.

The trillion euros lent out by the European Central Bank for three years at a rock bottom interest rates were supposed to do two things –  throw a comfort blanket around Europe’s wobbly banks and pump money into  moribund economies. Some new data from struggling Spain confirms that while there may be a bit of a case for the former, the latter is still falling short.

Mortgage lending by Spanish banks  had their largest annual drop in more than six years in February – coming in at essentially half of what they were a year earlier. There are all kinds of reasons for this, not the least being that large numbers of Spaniards are out of work and house prices are still tumbling with at least one estimate being that they remain as much as 30 percent overvalued.

But given that Spanish lenders were among the biggest taker of the ECB’s largesse  (officially known as  LTROs, a name only a central banker’s mother could love) the lack of trickle down  is less than bracing.  The suspicion is that Spain’s banks are holding back on lending because of their wonky balance sheets, which is of course a good thing in itself it it keeps the financial system on its feet.

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.