Not surprisingly, financial markets do behave in the same way as they did in the past few months. The DAX has only occasionally left the band between the 5,700 and the 6,200 threshold since mid-October. And market observers are more than divided on their 2012 outlook. Some fear that Greece might drop out of the Euro. Others even expect a break-up of the whole Eurozone.
Last week’s short-lived rallye ended as soon as market rumour had it that S&P would slash half of the Eurozone members’ sovereign ratings — some by two notches at once. And there are growing worries that some hedge funds might back out from the previously agreed 50% haircut on Greeek bonds in order to cash in on their credit-default swaps. However, all this sounds pretty familiar, doesn’t it?
If we take a closer look, the current struggles basically follow the same lines of reasoning between the same people as they have done for a couple of months.
Hawks vs. Doves
It is not quite clear if the European Central Bank has the nerve to follow the monetary policy approach of the Fed and the BoE in being a lot more leanient when it comes to the purchase of government bonds. Bundesbank’s Juergen Stark, the ECB’s former chief economist, is still rumbling against this idea.
However, the ECB’s interest rate policy already points into a different direction. While consumer inflation has left behind the ECB’s own limit (“close to, but below 2%”) for half a year or so, the ECB Council kept its main rate at 1% last week. And ECB president Mario Draghi seemed inclined to cut it even further, if only he could without compromising the central bank’s stability goals. More quantitative easing now may be a matter of time rather than a matter of principle.
Greece vs. Troika
Although Europe’s leaders are very keen on signalling their willingness to restore confidence in the markets, the Greek patient does not get better, instead it is getting even sicker. Greece is in its worst crisis since World War II, the economy may shrink for the fifth year in a row.
And yet, the only thing the so-called troika — consisting of the EU commission, the ECB and the IMF — seemingly can do is to meet and greet and see that not very much has been achieved so far in stabilising the country’s economy. Even a 50% haircut would not balance a 60% loss in GDP, this is what Greece now has accumulated over the past few years.
Hedge funds vs. more financial regulation
It is now quite obvious that many hedge funds are not really interested in being part of a “voluntary” haircut. As this would probably not be treated as a default, the funds’ insurance against such an event via credit-default swaps would be utterly worthless. If politicians, however, were to make the voluntary haircut a compulsory one, speculative attacks against the next ailing Eurozone member were to follow soon. In this case, it would have been a proven fact that week Euro members can indeed lose support by their stronger fellows.
After all, you cannot have the benefits of free capital markets and then shield yourself from the dire consequences. In other words, either the EU wants more financial regulation, then it may produce less growth and receive less tax income in good times. Or it may stick to the current approach which gives speculative traders a huge incentive to test the viability of the monetary union in troubled times.
US rating agencies vs. EU politicians
Whereas European politicians — and French ones, in particular — are often appalled by the power of rating decisions, US commentators such as Huffington Post’s Adam Levin think that rating agencies only put into action what markets have been digesting for several weeks already. This would mean rating agencies are not the problem but rather the bringer of bad news. Nevertheless, the call for a European-wide sovereign rating body is coming to surface from time to time. Germany’s Foreign Minister Guido Westerwelle did so during his latest visit to Greece.
The real problem, however, is that the Eurozone wants to be seen as one single economy but is rather acting like 17 of them (or even 27, if the non-Euro members are take into account). If Europe does not learn to adress financial markets with a single voice, market participants won’t show the necessary respect in the EU’s decision-making power.
Show must go on
Longer term, the EU has three options. It can allow a little bit more inflation and keep interest rates low. It can buy back government paper via the ECB and risk even more inflation. And it can show financial markets its commitment to unity by installing the ESM bailout fund as a foundation for some kind of European finance ministry. However, these are tough decisions and as such they will take some time. This is especially true in Europe.
Therefore, the Eurozone will likely move on with its muddling through in the short-term. This is not even the worst approach. Since its peak, the Euro has already lost one-third of its value against the dollar. More muddling through will destroy confidence and devaluate the Euro even more. This would help the Eurozone to export more as their products get cheaper aborad. The downside is that confidence might never come back once it has been lost. Traders can be unforgivable lovers when it comes to a currency’s appeal.
In Billy Wilder’s Academy Award winning movie “The Apartment” from 1959, the female protagonist comments on her ever-unreliable lover in the end: “Ring out the old year, ring in the new. Ring-a-ding-ding …”
It’s the same now with Europe’s single currency, it seems.
Photo credit: Flickr/ Miran Rijavec
It’s all a matter of perspective. Apparently, Europe’s leaders think they have done a fine job in securing the functioning of the EU in times of trouble. Okay, nothing definitely has been agreed upon, but at least everybody — well, apart from the UK, of course — has agreed to be willing to agree on … err … something, at some time to be specified in the future.
No kidding, in contrast to loftier expectations the only tangible result of the EU summit in mid-December has been the increase of the IMF war chest by €200bln. The details shall be fleshed out this Monday in a telephone conference.
As a matter of fact, markets have been deeply disappointed by this result. The Dax dropped nearly 5% from the beginning of the summit to the end of past week. Germany’s benchmark index ended at 5,701 on Friday with after-hours trading pointing to a further decline on Monday’s opening.
Rating agencies showed that they were annoyed by political tinkering, too. While S&P is considering to cut the EU’s own AAA rating, Fitch confirmed that it will lower the outlook for France to “negative” as well as downgrading six EU member states (among them Ireland, Italy, and Spain). Fitch even said a solution for the EU debt crisis seems out of reach now. This seems to be a little bit harsh, though.
If we take a closer look, neither of the two perspectives outlined above seems to be entirely wrong. However, they both don’t seem to be completely right, either. While the political class has been eager to show its ability to act, they completely failed to present a solution on how to provide the necessary liquidity for the financial system once investors mistrust both each other and the ailing Eurozone member states. The Eurozone banks’ overnight deposits with the ECB rose to an 18-month record last Monday. Everybody is anxiously watching who will slip next.
Ironically, the mistrust of the banks in the Euro area is a problem as well as a clue for a cure. As the banks deposit their excess money with the ECB, they at least show their trust in this institution. If Europe’s leaders could only agree to install the ECB as an unlimited lender of last resort, the mistrust would dwindle, the deposits would decline and the ECB might not even be in need to provide additional liquidity. This hardly seems “beyond reach”.
On the economical data front, there even has been some silver lining as of late. The ZEW indicator of economic expectations unexpectedly improved slightly last week and the experts there think a recession (i.e. two consecutive quarters of negative growth) is now less likely than before. This may become a mild winter, not only concerning the weather. If this week’s ifo index — to be released on Tuesday — confirms the positive trend, this might bring some relief to the market.
Photo credit: Flickr/ DavidDMuir
Markets have been suprisingly steady this week, given that S&P has threatened to cut the remaining AAA ratings in Europe due to the unsolved debt problems. The DAX kept well above the 6,000 line, although it lost about 1.3% on Tuesday. This could already be a sign that markets expect a real breakthrough for the EU summit on Friday.
EU monetary commissioner Olli Rehn stated last week that the EU was entering into a “critical period of ten days”. This period is nearly over now. For a long time, observers have been wondering if Ms. Merkel and Mr. Sarkozy would be able to hammer out a compromise on how to deal with the current debt crisis. I didn’t look that way for quite a while.
At least it seems clear now that it would not be done with a new regime for a stability and growth pact. The rating agencies would hardly be satisfied by that as the old pact was never adhered to in the first place — not even by the Germans, who had pushed hard to get this pact ratified. No, what the EU really needs is an amendment to its current treaties.
Given the usual political tinkering of the Brussells technocrats, such an amendment could take years. In this case, markets will give politicians three months at best. Still, the main line of arguing runs between the French and the Germans. While the French approach emphasizes the need for solidarity with struggling Eurozone members, the Germans want to enforce their law-and-order approach of punishing the wrongdoers.
Even though it seems very tricky to achieve a compromise on that matter, the EU’s leaders — with the rating agencies at their throats — have no other options but to start moving into the same direction. The rating agencies’ threat could play a catalyst role in finding a political solution out of the current dilemma. It may have been this rationale that kept markets afloat during the past few days.
How does a potential compromise look like? First, Germany will most likely insist on a tighter fiscal union. While the EFSF stability fund might be used as the political link, the European Court of Justice could act as an independent body of controlling national budget restrictions. Second, Eurobonds won’t be off the table once Germany’s urge for more fiscal unity has been satisfied. Third, concerning the broader ECB policy, an approach of “don’t ask, don’t tell” seems to be most likely, i.e. as long as politicians refrain from demanding action by the ECB, the latter will be free to buy government bonds in order to stabilize yields, if need be.
The details of the solution to be presented may vary. However, if the Eurozone leaders fail to present something more credible this time, it could spell desaster — not only for the markets, but for the whole Eurozone as well.
Photo credit: Flickr/ Graham Binns
Something is rotten in the states of Euroland. The imbalances that have been pilig up for a decade or so are finally becoming a threat to the very existence of the European project. The cries for action are getting more and more shrieking. And the ugly German has returned, this time in the adamant stubbornness of Chancellor Angela Merkel. No Eurobonds, no further ECB intervention, that has been her mantra for weeks.
But no, wait a minute. Take a closer look. This is not the Germans preparing for world war III by financial means. This is a game of poker. Ms. Merkel has just raised the stakes. Will the other Euro members fold or are they going all-in? To get an answer, we must analyse the current situation in more detail and delve beneath the rubble of cacophonies and misinformation.
On the one hand, we have states that reached the financial doldrums. Portugal dropped to junk status last week, as did Hungary (not yet a member of the Eurozone club, though). And Belgium got beaten by the rating agencies, too. Even France’s rating seems to be in danger now. Without the European stability fund (now nicely leveraged) or other means of bailout money, the weaker Euro states would be doomed soon. No serious institutional lender would entrust them the money he manages for his customers. Right so.
On the other hand, Germany cannot get any fresh money either. The yields on German goverment paper have dropped so much that the real interest rate has fallen below zero. When taking inflation into account, investors are now effectively doling out money to the Germans for the privilege of borrowing to them. This is absurd.
And although Germany is heavily opposing any more bond buying by the ECB, banks are now throwing away the PIIGS’ government money at prices that would enable the ECB to generate a hefty profit if it just bought a little bit more. This may be a neat way for the Eurozone of ridding itself of a nice chunk of public debt without any country actually going into default. True, this was never meant that way in the beginning. On the other hand, it is hardly surprising.
Many economists pointed out at the very start of the Eurozone that a permanent monetary union could not function without a fiscal union. This advise was ignored by the politicians back then. A fiscal union of any sort did not seem feasible at that time. Now, with the boat sinking and the water trickling in, the will for cooperation surely has increased. All European leaders know this, even Ms. Merkel.
If the Europeans want to keep their common monetary base, they will have to unite their financing base, too. Let’s look at the previous contractual arrangements as a kind of provisional solution. France and Germany are already fiddling around to find a way of amending the current regime without actually involving a large-scale meeting or approval by the European Parliament. This kind of backrooom-dealing is the way most of the important EU stuff had been handled for decades, anyway. It s not necessarily the worst approach to look only for those answers that can be agreed upon politically in a resonable time frame and to work out the more general principles later on.
The same line of reasoning applies to the ECB. It is a fitting coincidence that the ECB’s permanent residency is currently under construction in Frankfurt. Maybe some of the ECB’s statutes have to undergo a little reconstruction, too. And maybe this could include the idea of buying some more government bonds if need be. Markets have shown this week that they can be very cheerful as soon as the central banks agree to become a little bit less hawkish. The hawks are gone anyway.
The whole Eurozone now looks like a car that has been built while running at full speed already. A daunting task, as by now, we only have the chassis but we stil have to construct the body. If Ms. Merkel fails to present a conclusive solution on how to keep the weaker Eurozone states in line whithout suffocating them financially, the car will crash and the game will be over. And unlike a game of poker, this one would have no winners.
Therefore, let’s hope that the carrot-and-stick approach currently implemented by the German Chancellor will work. Granted, there is not plenty of time now, as a convincing answer should be reached before the next EU leaders’ summit in mid-December. Ideally, we then would have some kind of community financing, i.e. the notorious Eurobonds. At the moment, it is not quite clear if all Eurozone members would be part of the issuing club, or just the AAA rated countries. The others would still have to rely on the EFSF, or a new ECB bond buying program. But the storm would be over.
Too good to be true? Well, to quote Shakespeare once more, there are more things between heaven and earth than are dreamt in your philosophy …
Photo credit: Flickr/ Derek N Winterburn
Good news was scarce last week. At least the German ifo index had a small uptick, but this wasn’t enough to stem against the tide of bad omens: Rating downgrades — Belgium to AA+, Hungary and Portugal to junk status — as well as a financial deadlock in Europe and in the US was enough to send the DAX down to 5,493 by Friday. After-hours trading over the weekend points to a pretty flat opening on Monday.
The larger question now is: Will Germany eventually bow to EU and IMF pressure and allow the issuing of Eurobonds as well as a more active role of the ECB in combatting the crisis? On a deeper level of analysis, the answer is surely yes, even though Germany will demand a price — we will explore this in an upcoming comment this week.
On Monday, US President Barack Obama is hosting the annual US – EU summit. Given the current state of affairs, we wouldn’t expect much more than the usual blame game. This is futile. Actually, neither the Europeans nor the Americans did a terrible good job to calm markets in the past few weeks.
A quick solution is very unlikely now. And the deeper structural problem is hard to address: The baby boomer generation on both sides of the Atlantic is growing old. This means a smaller working population and ultimately less growth. Some observers already fear the US labor market may be mimicking the European one soon. In the end, debt levels will have to match growth levels again. This can mean more immigration or less spending, or probably a little bit of both. But long-term problems need long-term answers and this will hardly influence the day-to-day business in financial markets.
The German release calendar has CPI on Monday and retail sales on Wednesday. As the second half of the week is a bit quiet on the indicator front on the continent, traders will probably look at US non-farm payrolls on Friday. Anything that points to a milder recession than currently feared would be most welcome to stabilize the markets. This could establish a bounce-back from the current stock market levels once bargain hunters are stepping in again.
Photo credit: Flickr/ Jiligan86
What a month. Investors are trying their best to get any meaningful direction for manoeuvering through the current mess. However, with an unpleasant newsflow and large underlying uncertainties, we are rather in a trader’s paradise: aye volatility!
Let’s see: Italy has to pay record-high bond yields, the ECB intervenes (albeit still a bit timidly), the British premier is opposing a financial transaction tax (as he used to do) and the German Chancellor, Ms. Merkel, is easy on using dramatic words to describe the pickle the Eurozone has landed itself in.
Meanwhile, on the other side of the Atlantic, filibustering partisans are blocking an agreement on how to cut the budget.
Really, if Spain’s socialist premier had not lost general elections on Sunday, this would look exactly like the picture we already had three months ago! Needless to say that the DAX is nearly on the same level as at the end of August.
The German release calendar is relatively quiet this week, but the ifo indicator on Friday can give us another hint how fast we are sliding into recession. As European data is scarce this week, another figure to watch are US initial jobless claims, out one day earlier than usual on Wednesday (because of Thanksgiving).
All in all, its seems as if trader’s paradise is there to persist a little bit more.
Photo credit: Flickr/ Moyan Brenn
Things are going very well these days for Angela Merkel, the German Chancellor, and her ruling Christian Democrats. At the party meeting in Leipzig, German finance minister Wolfgang Schaeuble demanded a stronger political union in Europe and more financial regulation.
His colleague Volker Kauder, the parliamentary leader of the conservatives in the German Bundestag, proudly announced that Europe speaks German now – a remark that sent the pack of British tabloids howling for his bones.
Oh yes, it’s getting colder in Europe, not only because of a misty November. As the new governments in Italy and Greece are struggling to find ways out of the debt crisis, Spain’s premier Zapatero is faced with general elections next Sunday he cannot win.
Meanwhile, Ireland’s premier Taoiseach Enda Kenny is asking for more help from the ECB and the EFSF while at the same time turning down Ms. Merkel’s urge to cut his country’s budget. Mr. Kenny was shocked to hear that the German Bundestag was discussing papers on Irish austerity measures issued by his own finance ministry, ahead of the premier’s Berlin visit this week. What the hell is going on?
Well, listen and learn: “The task of our generation is to complete the economic and monetary union in Europe and to create a political union.” This is not some wet dream of a CDU party backbencher but the bold statement of Angela Merkel herself, given at this week’s party gathering.
Granted, British Prime Minister David Cameron emphasized that he wants to get competencies transferred back from Brussels, not the other way round. He will at least have his chance to discuss this position with Ms. Merkel this Friday in Berlin, just like Mr. Kenny did on Wednesday. But will he prove his point? Let’s face it: The time of exchanging niceties is over. Ms. Merkel is about to release her bloodhounds.
Many leaders in Europe’s debt-ridden countries would rather now than tomorrow prefer to see the ECB buying more of their bonds and the EFSF doling out ample supplies of cheap money, backed by European (i.e., German) guarantees. This will not happen, at least not now.
The German electorate is far from cheerful on the latest developments. Europe’s paymasters don’t like their vital role in shielding a currency that they never wanted to have in the first place, a currency that was a political price to pay in order to regain German unity in 1990. This very currency has allowed the PIIGS to borrow at low costs for more than ten years and to disguise the state of their budgets. This is how many Germans on the street see it.
At the same time, Germans had to shoulder one reform package after the other to remain competitive under the new currency regime. Social security was slashed, pensions were frozen, the pension age has been increased and real wages for around 80% of the working population have been falling or stagnating for fifteen years now.
Yes, Germany has one of the lowest unemployment rates in the EU. But more than a million fulltime workers now have to rely on additional welfare money, because their salaries don’t pay for a living. They do not even have a general minimum wage, though the conservatives are now discussing it for the first time ever.
Most Germans want their D-Mark back. They won’t get it, their politicians have other plans. But if Germans cannot have their D-Mark, all other Europeans shall suffer the way Germans have been suffering for years. Let them demonstrate and burn cars in the street in Italy or Spain, they will pay the price. Let them cry and throw stones against the police in Greece or Portugal. They will pay. They will learn what it means to have a hard currency. Or they will lose this currency and the EU will fall into oblivion. This is Ms. Merkel’s loaded gun.
Ms. Merkel perfectly plays the role of a good wife who has found out that her husband has been cheating on her. If he dismisses his mistress, the good wife will stay. Once he tries again to see his mistress, the good wife will see her lawyer and the marriage will fall apart. The PIIGS are the husband. Deficit spending is the mistress. A genereal referendum is the lawyer. And the EU is the marriage.
The German Chancellor has been generous enough to make the leaders of the debt-ridden states feel what it would mean to lose the Euro, to be tossed out of the EU or to lose the EU altogether. By now, they all know the consequence. With India, Brazil and China on the rise, a break-up of the EU would turn their little economies with their ageing populations into dust. They are all on board, now they all have to row – or they will have to swim and drown.
And what is about the British? Oh, they could surely swim alone, if they wanted to. The good wife won’t stop them.
Photo credit: Flickr/ European Parliament
“We now have to build the poltical union we did not build during the 90s,” Schaeuble said.
“This means a fiscal union and this means more regulation”, he added.
Photo credit: Flickr/ World Economic Forum
Through all ups and downs, the DAX has been holding remarkably steady around the 6,000 threshold during the past few weeks. Although the German benchmark index gained about 3.2% on Friday alone after the new Greek premier Lucas Papademos had been sworn in, it effectively only recovered the previous days’ losses. Thus, the weekly gain was below 1%.
Lucas Papademos won’t have an easy job but his country has at least found a meaningful direction. By having finally agreed to appoint a former ECB bureaucrat, the Greeks have chosen to ride the bullet, whatever it takes. They now have to endorse the Euro with all the budget cuts this will bring, or they will risk to drop out of the EU altogether. A similar picture emerged in Italy over the weekend, when premier Berlusconi stepped down after an agonizing struggle with his coalition members and former EU competition commissioner Mario Monti was called to the helm instead.
Mr. Monti had been once labelled “Super Mario”, when fighting against the vested interests of US company flagships such as GE and Microsoft. With the next installment of his adventures in Euroland about to begin, one really wonders why Mr. Papademos’ first name isn’t in fact Luigi — he would make a wonderful brother-in-arms for the Italian premier, not unlike the two characters in Nintendo’s famous video game series.
It cannot be emphasized enough that the Eurocrats really have taken over now. Mr. Monti has not backed down against an American software giant — why should he be afraid of tackling US rating agencies who might risk to drag down his country’s credit worthiness? After all, the situation in the Italian bond market doesn’t look quite like a picnic (the only positive aspect being that Germany’s short-term refinancing costs have dropped to virtually zero, as the liquidity has to go somewhere). There’s really no time to lose for Mr. Monti in regaining the public’s confidence as a recession in Europe is looming already.
Angela Merkel, the German Chancellor, might chuckle about all this. If this blog’s notion is true that her aim always was to integrate the EU even more by threatening to toss the weaklings out of the Eurozone, she might win her bet. We will follow that line of thought in an upcoming comment this week.
Concerning the stock market, we would expect a rather friendly opening on Monday as the governmental shift in Italy has not been priced in yet. For the rest of the week, a further dithering around the 6,000 mark seems most likely as long as economic indiactors don’t point to an accelerating cool-down of the business cycle. For the moment, the opposite seems more likely — recession will come, but it may take a few months more to do so. This week’s German release calendar has the ZEW indicator and quarterly flash GDP on Tuesday as well as PPI on Friday, these numbers will hopefully shed some more light.
And for all the sit-on-your-pants traders with the usual itchy finger: Let’s give Super Mario and his fellows a little bit of time. Things have been looking a lot worse in the past few weeks than right now.
Photo credit: Flickr/ Brighton photographer
The Greek premier proposed a referendum on the EU’s austerity package for his country, had to face harsh criticism for that move by Germany and France, was threatened with early elections, scrapped the referendum idea, had to counter fears that Greece would soon drop out of the Euro (or even the EU), won a vote of confidence on Saturday and nevertheless agreed to step down on Sunday evening.
Papandreou tried too hard and too late. After a real rollercoaster ride, he pushed himself out of bounds. Game over.
A new Greek technocrat goverment formed by socialists and conservatives alike shall watch over the execution of the EU-ordered budgetary cuts and Papandreou won’t be part of that. Some sources claimed that former ECB board member Lucas Papademos could be the right man to do the job. Once the new government’s business will be completed, elections will be held in Greece.
The DAX followed the ups and downs of the political turmoil and finished the week just below the critical 6,000 threshold. Not even a surprise rate cut by the ECB, now headed by Mario Draghi, could set things right. All hopes that the G20 summit in Cannes would lead to more material results to cope with the crisis evaporated in due course. The only tangible idea was to refinance the EFSF crisis fund via extra special drawing rights, issued by the IMF. However, this motion was turned down by Germany.
The main topic now, i.e. whether Greece will exit the Euro or not, is still being debated intensely. Although some Greek news sources over the weekend did indeed claim that an exit from the Eurozome could be reached almost immediately, its is not quite that easy. The Lisbon treaty only allows a country to exit the Eurozone while parallely exiting the EU (which nobody wants Greece to do). Naturally, an agreement of some sort can be reached but that may take some time. Until then, nobody really knows.
There is not much room for celebrating now. Germany, the locomotive of the European economy, is still losing steam. The German release calendar has industrial production on Monday, trade balance data on Tuesday and final CPI on Thursday. Anything that indicates a further cooling of the economy at this point could additionally dampen an already tense market sentiment.
I would guess that upcoming quarterly numbers to be reported in the coming week, e.g. by Munich Re, would have to be of an extraordinarily sound quality to stem against the tide of probably sobering news. And, apart from financials, which single stocks really matter in these troubled days?
Photo credit: Flickr/ Thyago