MacroScope

The American people have spoken but for the markets the votes of 300 Greeks could be of even more importance in the short-term. German Bund futures have opened flat, not really reacting to Obama’s victory, while European stocks have eked out some early gains.
       
We await a knife-edge parliamentary vote in Athens on labour reforms to cut wages and severance payments, which the EU and IMF insist are a key part of a new bailout deal, but which the smallest party in the coalition government has pledged to vote against. That leaves the two larger parties – New Democracy and PASOK – with a working majority of just nine lawmakers and on a less contentious vote on privatizations, a number of PASOK deputies rebelled. Ratcheting up the pressure is a second day of a general strike which will see thousands take to the streets.

We know that the troika has advised that another 30 billion euros needs to be found to keep Greece afloat. We also know that the IMF has been pressing for the ECB and euro zone governments to take a writedown on Greek bonds they hold, which Germany refuses to do so (which means it won’t happen, for now at least). The Eurogroup is awaiting the troika’s final report and it’s looking less likely that a definitive plan will be signed off at next Monday’s meeting of euro zone finance ministers.

Nonetheless, it’s in no one’s interests to let Greece crash at this point so the presumption is a deal will be done, probably featuring Greece getting two extra years to make the cuts demanded of it, extending maturities on its loans and cutting the interest rates. Talk of the ECB foregoing profits on the Greek bonds it holds (rather than taking a loss, since it bought them at a steep discount) continues to do the rounds. A further German condition is for a ring-fenced escrow account to hold some Greek tax revenues to ensure that it services its loans. Greece will probably also be allowed to issue more t-bills to tide it over though that requires the ECB’s acquiescence since Greek banks are entirely dependent on central bank liquidity and have been offering those t-bills up as collateral. Mario Draghi is speaking today.

El Pais scooped the most interesting part of the European Commission’s updated forecasts, reporting that Brussels expects a deeper Spanish recession which means it will miss its budget deficit targets for the next two years which raises the pressure on Rajoy to take a bailout. But the other figures will be of interest too. The Italian press has got an early leak of Italy’s numbers, which forecast a shallower recession in 2013 and a shrinking deficit, down to about 2 percent of GDP. Looks like Spain is in significantly worse shape.

The EU budget saga will heat up again when Angela Merkel meets David Cameron in London this evening. Cameron has called for a real-terms freeze in EU spending to reflect national austerity policies and has threatened to block a deal otherwise, potentially holding up an increase in funding for the poorest  member states. In reality, he doesn’t expect to get a freeze and the German position is not that different to the Brits. Expect some accounting chicanery to satisfy all sides.

Following Silvio Berlusconi’s threat to demolish Mario Monti’s government, Italy will try to sell up to four billion euros of five- and 10-year bonds at auction today. It will get away but investors could be forgiven for being nervous. Monti was in Madrid yesterday and issued a veiled plea for Spain to seek help from the euro zone rescue fund, which would trigger ECB bond-buying, in the hope that would drive down Italian borrowing costs too. But Spain, with nearly all of its 2012 funding done, is in no hurry.

Monti continues to insist Italy doesn’t need to seek help itself but said the ECB needed to be seen in action, rather than just offer speculators the threat that it could intervene, in order to keep the euro zone shored up. One suspects that is true.

Also last night, Sicilian election results showed the centre-left Democratic Party and anti-establishment 5-Star movement cleaned up at the expense of Berlusconi’s party. Perhaps the most worrying figure was the record low turnout by an electorate disillusioned by constant austerity. The possibility of Monti retaining the premiership after spring 2013 elections has helped keep market attacks at bay. In reality, that looks unlikely although he could take over the presidency to retain some voice and influence. The fractured nature of Italian politics raises the threat of no solid government emerging from the general election. Fitch cut Sicily’s rating to BBB late yesterday and warned of more to come.

The Greek standoff continues. The Democratic Left, a junior party in the government’s coalition, could not be swayed and said it would vote against labour reforms demanded by the EU and IMF, so a deal putting Greece’s bailout terms back on track remains elusive.

Just as worryingly, Reuters secured an advance glimpse of the EU/IMF/ECB troika’s report on Greece which showed the debt target of 120 percent of GDP in 2020 will be missed (surprise, surprise) and as things stand will come in at around 136 percent. In other words, 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 European Central Bank and euro zone governments.

We know the IMF is very keen on the latter, believing that is the only way the numbers can be made to add up. We also know that Germany and others are just as resistant. Other schemes, such as Athens using privatization proceeds to buy back bonds, which has inbuilt leverage since it can do so at a quarter of their face value, may yet come into the mix but don’t alone look like they’ll make enough of a dent in Greece’s debt mountain. Athens looks set to get the extra two years it requested to make the cuts demanded of it, which also falls into the “necessary but insufficient” category.

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.

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.

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.

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.

Moody’s put Germany on notice that it might cut its credit rating and did the same for the Netherlands and Luxembourg. It cited a growing chance that Greece could leave the euro zone, and the contagion and costs that could flow from that, as well as the possibility that Berlin might have to increase its support for Italy and Spain. Both are self-evident risks and markets have not really reacted though it’s interesting timing that Spanish Economy Minister de Guindos is meeting his German counterpart, Wolfgang Schaeuble, in Berlin later. The Moody’s warning could also feed into darkening German public opinion about the merits of offering any more help to its sick partners.

German Bund futures opened just 10 ticks lower and European stocks edged higher after a sharp Monday sell-off. A jump in China’s PMI index has helped sentiment a little. The euro remains on the back foot but if it continues to fall that should actually help euro zone economies, making their exports more competitive. We’re programmed to treat government statements with scepticism but it’s hard to argue with the German finance ministry which said last night that the risks cited by Moody’s were nothing new and the sound state of German public finances was unchanged.

Nonetheless, reminders of the depth of the debt crisis are close at hand. So dislocated is the Spanish debt market that is hard to gauge what costs Spain will be required to pay at today’s T-bill auction because a combination of summer holidays and worries about the country’s finances mean trading has virtually dried up. With benchmark bond yields hitting euro-era highs on Monday, however, the debt sale of 3 billion euros in 3- and 6-month bills is likely to be expensive.
Also last night, clearing house LCH.Clearnet SA  increased the cost of using Spanish and Italian bonds to raise funds via its repo service, which could put further upward pressure on already surging yields.

Greece announced late yesterday that it would need a bridging loan to tide it over until it finds the nearly 12 billion euros of spending cuts demanded by the EU/IMF/ECB troika of inspectors, after which the next tranche of bailout money can flow, probably in September. The troika is due to return next week. There’s no doubt Athens will get the interim money. Jean-Claude Juncker, who chairs the group of euro zone finance ministers, said last week that nobody should fret about Greece’s finances in August. They would be shored up.

Today, Finance Minister Yannis Stournaras is expected to put a draft list of cuts to the leaders of the three parties comprising the country’s ruling coalition, who are rather hemmed in by pledges to voters not to fire civil servants and shun sweeping pensions and public sector wage cuts.

Italian Prime Minister Mario Monti threw in a curve ball last night, saying there was a real prospect that the autonomous island of Sicily could default. It accounts for about 5.5 percent of Italian GDP so shouldn’t wreck the country’s finances but it’s not a step in the right direction. If Italy’s debt mountain of 120 percent of GDP started rising rather than falling, it could be taken very badly by the markets.