MacroScope

Bridge of Sighs

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.

With Monti saying he will not be a candidate in elections of spring next year, Italy could quickly eclipse Spain as the biggest threat to the euro zone. Monti has enacted some serious labour and structural reforms but already they are running into stiff opposition. Whether whoever replaces him next year would be willing and able to continue down the same path is a very big question.

Internal German politics offers a microcosm of the wider euro zone stand-off between rich countries who have had enough of bailing out the poor and profligate. Yesterday, the wealthy southern state of Bavaria – a stronghold of Merkel supporters – said it would ask the constitutional court to back its call for an overhaul of the federal system whereby it bankrolls poorer German states. This is a touchy subject for the Chancellor who finds herself of defending the sort of transfer payments domestically that she strongly opposes in the wider currency bloc. The court is already taking its time over ruling on the euro zone’s ESM bailout fund, delaying its inception until September at least.

Investors could pay for the right to hold two-year German paper for the first time ever at an auction this morning – a stark pointer to the extent of risk aversion out there.

For Spain, all eyes are on Thursday’s bond auction after a T-bill sale saw yields fall significantly on Tuesday. Portugal, which got a thumbs up from the IMF for its austerity drive earlier in the week, sells six- and 12-month T-bills today.

Slow slow quick quick slow

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.

None of that is likely to be signed off tonight, particularly since so much hangs on the banking supervision plan. That is the nub of it. The summit deal was not unimportant but is on a much slower track than markets will countenance. There were also some notable absences from the discussion in Brussels, such as a euro zone deposit guarantee fund which could prevent any threat of a bank run.

In fact, there has already been signs of unraveling with the Finns and the Dutch resisting the ESM rescue fund being able to act in the secondary bond market (though not the primary) and Berlin making quite clear that claims from southern Europe that bond-buying support would not have strings attached for government are simply not true. The central question as to whether individual countries or the euro zone assumes liability for banks that are rescued by the ESM remains open. Monti blamed the latest widening of bond spreads squarely on the Finns, suggesting unity really is fraying.

Heaping uncertainty upon uncertainty, the ESM will not come into being as planned today because Germany’s constitutional court will take time on Tuesday to examine complaints about the permanent bailout fund, though the judges are not expected to block it. Germany’s president says he won’t sign it into law without the court’s go-ahead. A minor delay will pose no problem. A lengthier one could jolt investors.

The Eurogroup could  also be a baptism of fire for Greece’s new finance minister. He has conceded that Athens was off-track with  its bailout obligations, after meeting the troika of EU/ECB/IMF inspectors. Athens is seeking up to two more years to meet its debt-cutting targets but is unlikely to get cut that much slack. Yannis Stournaras reiterated on Saturday that Athens needed more time but pledged to press on with structural reforms and a privatization drive.  The privatisation agency will accept Greek government bonds as payment in a bid to encourage investment. Greece will probably run out of money next month without further bailout aid being paid over.

Waiting for the summit

Cyprus became the fifth euro zone country to seek a bailout last night though its needs – maybe up to 10 billion euros – will not put a dent in the currency bloc’s resources. We’re still waiting to see precisely how much money Spain will take for its banks of the 100 billion euros offered. Moody’s cut the ratings of 28 of 33 Spanish banks by one to four notches last night, an inevitable consequence of the sovereign downgrade earlier this month.

Markets seems to have decided that they will be disappointed by the crunch summit at the end of the week. There was a somewhat discordant meeting between the big four euro zone leaders on Friday, with Germany’s Merkel refusing to budge in key areas, but she and French President Francois Hollande have the chance to strike a more positive note when they meet bilaterally on Wednesday abnd hot off the press we have a meeting of the finance ministers of Germany, France, Italy and Spain this evening — so maybe there is a concerted effort to get on the same page.

Lael Brainard, the U.S. Treasury guru who liaises with Europe, spoke for the rest of the world when she told us in an interview that EU leaders had to put “more flesh on the bone” of their ideas to resolve the crisis.

The intention for the summit is to set out a road map to economic and banking union. EU officials hope the latter can be done in a year, though Germany is only happy to consider vital aspects such as a deposit guarantee structure once the path to fiscal union is set in stone. That requires treaty change and will take a lot longer. And even if a banking union was in place this time next year, it would not resolve the immediate crisis.

A strong signal of intent at the summit might settle the markets, not least because it could be crucial in persuading the ECB to hold the fort if needed, although its levers are not problem-free. A widely expected interest rate cut probably may not make much difference, its three-year money splurge bought three months of time last time, maybe less if it does it again, and would reinforce the “doom loop” of weak banks and sovereigns leaning on each other for support. Reviving the bond-buying programme faces stiff internal opposition and, since the ECB is now viewed as a preferred creditor having avoided a writedown as part of the second Greek bailout, it could drive private investors out if it came in. ECB hardliner Weidmann was out last night saying the central bank had reached the limits of its mandate but in extremis it would surely act again as that would be precisely in line with its mandate to maintain financial stability.

Today we have Spain selling up to three billion euros of T-bills, Italy pushing inflation-linked bonds and the Netherlands offering 10-year debt. The latter should benefit from demand for “core” assets.

Greece remains chaotic with the prime minister missing the EU summit due to eye surgery and the newly-picked finance minister resigning after collapsing last week. The two men had been set themselves the task of softening Greece’s bailout terms but now the EU/IMF/ECB troika of inspectors has delayed its return to Athens.

Spain … Of bonds, banks and bailouts

It’s well and truly a Spain day. Its 10-year yields may have ducked back below the 7 percent pain threshold but Madrid’s auction of two-, three- and five-year bonds could still be tricky. It is only aiming to sell up to 2 billion euros and should manage to thanks largely to weak Spanish banks buying them up but the five-year bond is likely to command yields last seen in 1996.

After that, an independent audit of Spain’s stricken banking sector is due to be published which will give a guide as to how much of the 100 billion euros offered by the euro zone the banks need to take to be recapitalized. Madrid may then make a formal request for aid at a meeting of euro zone finance ministers later in the day. We’ve had from sources that the audit will say up to 70 billion euros is needed but Spain would be well advised to take more to try and convince markets that it has all bases covered.

The audit is expected to divide the banks into three groups: the weakest regional savings banks heavily exposed to bad property debts, a group of mid-sized banks which face temporary liquidity problems and two ‘good’ banks – BBVA and Santander – that won’t need any help.

The announcement of the bank bailout two weeks ago did nothing to alleviate the pressure on Spanish borrowing costs. One reason was that if the money came from the euro zone’s new ESM rescue fund, it would be a preferred creditor over private investors who could then lose out in the event of a default. With the ESM only up and running at some point in July, one solution could be to start the bailout via the existing EFSF then switch it to the ESM, thereby operating under the former fund’s rules which say nothing about subordination. The Eurogroup could shed some light here too.

It has much else to discuss besides. No decision will be taken on whether to relax Greece’s bailout terms until the EU/IMF/ECB troika has returned to Athens to see how far off track Greece is but it seems a done deal that Spain will be given an extra year to meet its 3 percent of GDP budget deficit goal. That could come up.  Cyprus is to decide by the end of the month whether it too needs a bailout to recapitalize its banks which have been damaged by the Greek crisis. That could well be discussed in Luxembourg too.

The idea floated by Italy’s Mario Monti at the G20 summit, for the euro zone rescue funds to buy Italian and Spanish bonds direct, has failed to gather momentum. Nonetheless, it was that that has taken the edge of Spanish and Italian bond yields. Denials from Brussels and Berlin have been fairly emphatic – Germany’s Angela Merkel, back from the G20, described it as a “purely theoretical” question which was not being discussed.

Finnish PM Katainen, who also rejected the idea, put his finger on it, saying the funds were not big enough to turn the secondary bond market around. That’s almost certainly true given the ECB had to spend up to 14 billion euros a week in Italy’s defence last year. Anything like that – and the effects were pretty short-lived anyway – and the 500 billion euro ESM would soon look utterly incapable of handling a sovereign Spanish bailout so the much-vaunted firewall would have been trampled underfoot. Then there is the seniority problem highlighted by the reaction to the Spanish bailout offer. With the ESM having preferred creditor status, if it piled in, private investors might head for the exit.

No Greek relief for pain in Spain

There was no Greek relief rally (though at least we had no meltdown) and Spanish 10-year yields shot back above seven percent as a result, setting a nasty backdrop to today’s sale of up to 3 billion euros of 12- and 18-month T-bills.

Madrid has had little problem selling debt so far, particularly shorter-dated paper, but it’s beginning to look like the treasury minister’s slightly premature assessment two weeks ago that the bond market was closing to Spain is beginning to come true. The 12-month bill was trading on Monday at around 4.9 percent. As last month’s auction it went for a touch under three percent. If that is not hairy enough, Spain will return to the market on Thursday with a sale of two-, three- and five-year bonds.

We’re still awaiting the independent audits of Spain’s banks which will give a guide as to how much of the 100 billion euros bailout offered by the euro zone they need. Treasury Minister Montoro was out again yesterday, pleading for the ECB to step in – presumably by reviving its bond-buying programme – something it remains reluctant to do, although a strong sense of purpose and commitment on economic union at the EU summit in a fortnight could embolden the central bank to act.

At the  Mexico G20, euro zone leaders agreed to move towards a more integrated banking system, breaking the negative loop whereby weak countries bail out their weak banks who in turn by the debt of their government which is declining in value, driving both into a negative spiral. They also talked up their plans for fiscal union. We’ll hear more of this at their end-June summit though much of it could take years to put in place. Berlin has so far refused to countenance a full banking union, including deposit guarantees, until the path to economic union is set in stone. Were there hints in Los Cabos of some softening on that?

Germany has crossed some of its red lines recently and there were hints in the G20 draft communiqué that it could be prepared to acquiesce to demands it should consume more, although we’ll await proof of that since it would be possible for Europe to point to its hitherto anaemic growth strategy as justification. The G20 said in its draft communique that countries without heavy debts problems were ready to act together to spur growth, if the economy slows a lot more.

The IMF finally secured a Chinese pledge to boost its war chest to over $450 billion. The official line had been that the resources would be for non euro zone countries drawn innocently into the fray. Last night Lagarde said they could help meet the financing needs of all financing members and were there as “a second line of defence”, the inference being the Fund will if necessary bolster the euro zone’s rescue fund.

Back to Greece. It looks like conservative New Democracy will form a pro-bailout coalition government with socialist PASOK today. They will have a workable majority, holding 162 seats of the 300 in parliament, and could get the support of the smaller Democratic Left too. But given the two traditionally dominant parties summoned not much more than 40 percent of the vote between them, meaning a sizeable majority voted for anti-bailout parties, SYRIZA will feel emboldened to lead stiff opposition within parliament and without. This government looks anything but secure and money is running perilously short.

Battening down the hatches

There’s a high degree of battening down the hatches going on before the Greek election by policymakers and market in case a hurricane results.

G20 sources told us last night that the major central banks would be prepared to take coordinated action to stabilize markets if necessary –- which I guess is always the case –  the Bank of England said it would  flood Britain’s banks with more than 100 billion pounds to try and get them to lend into the real economy and we broke news that the euro zone finance ministers will hold a conference call on Sunday evening to discuss the election results – all this as the world’s leaders gather in Mexico for a G20 summit starting on Monday. Bank of England Governor Mervyn King said the euro zone malaise was creating a broader crisis of confidence.

The central banks acted in concert after the collapse of Lehmans in 2008, pumping vast amounts of liquidity into the world economy and slashing interest rates. There is much less scope on the latter now. The biggest onus may fall on the European Central Bank which may have to act to prop up Greek banks and maybe banks in other “periphery” countries too although the structures to do so through the Greek central bank are in place and functioning daily. In extremis, we can expect Japan and Switzerland to act to keep a cap on their currencies too. As a euro zone official said last night, a bank run might not even be that visible and start on Sunday night over the internet rather than with queues of people outside their local bank on Monday morning.

But there’s probably a greater likelihood that markets won’t melt down on Monday. A startlingly strong victory for the anti-bailout SYRIZA would cause serious tremors but far more likely is an inconclusive result which leads to days of horse-trading over the formation of a government. And there’s also a strong chance that pro-bailout New Democracy comes first and claims the 50-parliamentary-seat bonus. That would put it in pole position to form the next government, an outcome that could see markets rally strongly and take pressure off Italian and Spanish borrowing costs. Whatever the result, it’s hard to see a durable, stable government being formed so if there is any relief, it could prove to be short-lived.

The odds of dramatic coordinated global action on Monday are probably fairly long and will clearly be dictated by events. However, it is also clear that the prospect of more measured action – as from the Bank of England – is increasingly likely. A Federal Reserve policy meeting next week will have markets travelling in hope though they may arrive with disappointment.

Today, we have ECB chief Mario Draghi and others speaking at a Frankfurt conference with Germany’s Merkel and Schaeuble also in public. His colleague, Bundesbank head Jens Weidmann, is already out saying the euro zone can’t allow any country to blackmail it with the threat of contagion.

Euro zone survival is in the eye of the beholder

Andy Bruce

Jun 14, 2012 08:55 EDT

Despite all their years of experience and complex mathematical models, for economists the question of the euro zone’s survival really has them at the mercy of national bias… at least in terms of where their employer is based.

One of the key points from the latest Reuters poll was that a majority of economists from banks and research houses around the world – 37 out of 59 – expect the euro zone to survive in its current form for the next 12 months.

But behind that headline figure, the answers were skewed heavily by region.

Only 5 out of 24 economists from organisations based inside the euro zone thought it would fail to survive in its present 17-nation form over the next 12 months.

But nearly half (17 out of 35) of those employed by institutions based outside the euro zone – British, North American, Scandinavian or Swiss – expected to see at least one country leave the currency union over the next year.

“Will the euro zone survive in its current form for the next 12 months?” sounds like a scientific question. But clearly the answer depends at least partly on the locale of an economist’s employer, rather than economics.

In the shadow of Greek elections

Italy, rapidly moving centre stage after the euro zone’s failure to assuage markets with a 100 billion euros Spanish bank bailout, faces a crunch bond auction. Having paid four percent to borrow for a year yesterday, it is likely to fork out over five percent for three-year paper although the smaller than usual target of up to 4.5 billion euros means the sale should get away. It will also issue a smattering of 2019 and 202 bonds.

Technocrat prime minister Mario Monti’s honeymoon period is over with even some he would have considered allies decrying the slow pace of his reform programme. Already this week he has appealed to Italy’s fractious political parties for support in keeping the austerity show on the road. Today, Monti hosts France’s Francois Hollande. They agree on a lot – the need for a stronger growth strategy, a banking union established sooner rather than later and a longer-term goal of euro zone bonds. Berlin, with the possible exception of the first goal, definitely does not.

Moody’s slashed Spain’s rating to just one notch above junk last night. The power of the ratings agencies to shock is significantly diminished but if Spain’s sovereign rating drops further, more of whatever non-Spanish bank private investors are left will be forced to head for the exits. Moody’s noted that the bank bailout will increase Spain’s debt burden and the dangerous of loop of damaged banks being the main buyers of Spanish government debt which is falling in value. It repeated its warning that euro zone ratings could be cut further if Sunday’s Greek election were to increase the chances of that country leaving the euro.

We interviewed EU competition chief Almunia late yesterday who said Spain may need to wind down one of its bailed-out savings banks and later we get data on how much Spain’s banks borrowed from the ECB last month.

On Greece, plans must be afoot for the aftermath of the election. It looks likely that the bloc will give Athens an extra year to make the spending cuts demanded of it if there is any sort of government which will continue with the bailout. Spain has just been granted the same with Germany’s blessing. PASOK leader Venizelos asked for precisely that while New Democracy chief Samaras wants two years more. Most sane judges think a third bailout and a fundamental reappraisal of the austerity programme will be needed to stop Greece falling off the rails at some point, but there’s not much prospect of that coming quickly. And what will the ECB do? Presumably it stands ready to prime Greek banks with even more liquidity.

There are many good reasons to keep Greece in the euro zone even if it did default – not least the chaos that would ensue, resulting in an essentially failed state that would have to be flooded with aid. Cyprus added to the list yesterday, saying it may look to Russia and China rather than Europe for money to prop up its banks which have been holed below the water line by their exposure to Greece. That would be a move of huge geopolitical implications. If Greece contemplated the same it would be even more so.

Interestingly, Washington in the guise of Treasury Secretary Geithner is urging the rest of the euro zone to get behind Germany’s push for fiscal union, calling for a maximum of clarity on the plans as early as possible. In a distinct change of tone, he said it was unfair to look at Germany as the sole source of the problem. Expect much more on this at next week’s G20 though doubtless Merkel will come under serious pressure as well.

Euro zone on the move … too slowly?

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.

The governmental measures that could make a real difference – a banking union with a bloc-wide deposit guarantee scheme and common euro zone bonds – look a long way off although pressure is seriously mounting for the former with ECB chief Mario Draghi and Italian premier Mario Monti, among others, hollering for it. It is likely Germany would only be in favour after a lot of progress had been made on the economic union front. And no one has yet explained where the vast funds needed to underpin euro zone bank deposits and create a structure to deal with failing banks would come from. But the mere fact that such dramatic measures are being discussed marks a step change in the bloc’s crisis management. Is it quick enough?

The ECB’s monthly policy meeting looms large over the week. It will produce updated economic forecasts likely to show the euro zone will contract more deeply than it had thought this year. That could serve as a hint that it could move to shore the currency bloc up.

The ECB and European Commission have floated some radical ideas over the past few days – on top of the bank stuff and the proposal to give Spain more time to cut, there are suggestions that the new ESM rescue fund could be allowed to lend to banks direct. Barring the relaxing of fiscal timetables, everything else looks difficult to put in place quickly, and it may have to be.

On the ESM, the process of ratifying its powers is still going through some national parliaments and was passed by others with very little enthusiasm. To change its remit to allow it to lend direct to banks would require the entire ratification process to be started again in the 17 countries. That would take months at best and some may well not pass it second time around. However, Spain continues to push for it and Washington is keen too.

Time to get real?

Spain’s plans to revive Bankia with state money and sort out its regions’ finances have well and truly unnerved the markets. It seems that Plan A — to inject state bonds straight into the stricken bank so that it could offer them to the ECB as collateral in return for cash — was roundly rejectd by the European Central Bank, so Madrid rapidly produced a second plan which will involve the government raising yet more money on the bond market, not helpful to its drive to cut debt.

That leaves the impression that Spain is making up policy on the hoof, not something likely to endear it to the markets. That’s particularly unfortunate since it has actually done an awful lot on the austerity and structural reform front over the past two years. But not enough.

It’s not all one-way traffic. Madrid is pressing its insistence that the ECB should be the institution to deliver a decisive message to the markets that the euro is here to stay – presumably by reviving its bond-buying programme (highly unlikely at this stage).

Spain’s big plus was that it had issued well over half its 2012 debt needs in the first five months of the year but with some of the Bankia recapitalization set to fall on the state and its indebted regions having to refinance far, far more debt than had been anticipated that advantage has been eroded. The government is set to impose a new mechanism on Friday to provide funds to the regions with strict strings attached.

For the next couple of month things aren’t too acute but the country faces hefty refunding humps in August and October which could prove difficult. It will want borrowing costs to be significantly lower by then which will require measures to foster investor confidence.

There has been talk among EU officials of giving Spain an extra year to get its budget deficit down to 3 percent of GDP if it presented a credible 3-4 year plan of fiscal adjustment, which would give important leeway. It is currently tasked with lopping about 6 percentage points off the deficit in two year; most economists say anything more than 2 points a year chokes the economy. Something may be afoot.  A government source told us last night that Spain would put forward a three-year plan to control central government spending in the months to come.

We may also get  hints of movement in that direction from Brussels with the European Commission putting forward its policy recommendations for all EU states. That could be the point at which it admits what everybody is saying: that Spain and others will be unable to meet the budget cuts demanded of them. It does not automatically flow that high debtor members will be given longer to meet their fiscal targets but it will certainly fuel the debate. It should be noted, though, that the noises from Berlin are not supportive.