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.
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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.
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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.
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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
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?
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Due to the happy result of the EU summit on the EFSF and the Greek default solution, the DAX rallied last week and gained a lot of lost ground. It ended at 6,346 last Friday and was called about 0.5% higher in after-hours trading on Sunday evening. So, is everybody being happy again?
Unfortunately, some major problems remain unsolved. The first problem is a rather technical one, but it can have a material impact on investors’ future strategies. Although Fitch already anounced that the major rating agencies will probably treat the Greek solution as a “technical default” (as we always expected), the International Swaps and Derivatives Association (ISDA) said it is unlikely that credit insurances in form of CDS will be paid out. After all, the haircut was a voluntary one! Ahem, yes. But if we treat this haircut as voluntary, a robber in the street threatening you with a gun could claim in court that you gave your purse to him on a purely voluntary basis, too.
If the ISDA notion survives, the CDS market will likely collapse. After all, nobody needs a default insurance that doesn’t pay in case of a default. However, if investors lose a now common tool to shield themselves against losses, they will likely demand higher risk premiums. This could make financing for the PIIGS even harder as their borrowing costs increase further. Italy last week had to pay the highest yield on new government bond isssues — 6.06% — since the start of the monetary union.
The second problem is where to take the money from that the EU will need to leverage the EFSF beyond the agreed €440bln. Some politicians are already flirting with China as a lender of last resort, but this could be a dangerous move. Firstly, China’s own financial system is far from stable. Large industrial companies are giving their excess cash to small and medium-sized enterprises in form of illegal loans. This shadow banking system is already fuelling inflation. Secondly, although China’s main goal is to keep the markets of its main buying countries afloat, it doesn’t want to bear the pain that arises from adjusting the current trade imbalances. Fresh Chinese money would only postpone the restructuring process elsewhere.
Thus, the deep, structural differences in the Eurozone remain. This is the third and the biggest problem. While Germany has gained productivity since the itroduction of the Euro, the PIIGS have been falling behind. Germany (and France, for that part) have bought the weaker Eurzone members some time to fix their budgets. But if they don’t, they are doomed nonetheless. Germany has bailed them out for now, it won’t bail them out in the bitter end. And the only other option would be to inflate the debt away, which does not sound well in the ears of German voters, as Richard Bath noted in The Scotsman on Sunday.
As the next G20 summit in Cannes ill follow suit on Thursday, the UK’s prime minister David Cameron may search for a kind of financial bazooka to calm markets for once and for all. He may be mistaken. It is far simpler than that: Either the PIIGS are starting painful reforms in earnest — or the Eurozone will eventually break up, leveraged EFSF or not.
Although the earnings season is up and running this week, all eyes will likely be fixed on the G20 meeting. And as a breakthrough on the structural matters is highly unprobable this time, we should be prepared for some hefty profit taking. We are not out of the woods, yet.
Photo credit: Flickr/ Shaheer Shahid
The DAX followed a volatile course in the past few days, dropping straightly for the better part of the week on bad sentiment indicators but gaining ground on Friday afternoon after the start of the big Eurozone summit. In the end, Germany’s benchmark index ended nearly flat for the week at 5,970.
This week has the start of the autumn earnings season with Deutsche Bank’s quarterly numbers as a kick-off on Tuesday. However, markets will hardly be listening to the bank’s earnings prospectives but will probably rather focus on CEO Josef Ackermann’s remarks on the current debt crisis. While most Eurozone officials want to recapitalize banks with up to €100bln, Ackermann claimed that the real problem is not the banks’ capital but the fact that government paper has lost its risk-free status.
Politicians simply fear a domino-like effect on banks once the haircut for Greece has been carved out. After an initially proposed risk participation on the banks’ side of about 21%, estimates now range from 50-60%. A lil’ bit more, anybody?
In effect, this would be the partial default this blog has been envisaging for three months now. The formerley unspeakable would become reality: a Eurozone member reaching insolvency. One cannot deny the fact that Mr. Ackermann’s remarks may be hurtful but true. As this blog already argued last week, banks don’t want to be the scapegoat for all that big-spending politicians like Itlay’s premier Berlusconi.
In the end, a solution might still entail a kind of recapitalization but bankers should mainly fear tougher regulation. At the moment, Europe’s politicians stand with their backs to the wall. Either they reach a convincing agreement by Wednesday which stabilizes the financial sector and reinstalls trust into the politicians’ fiscal austerity. Otherwise, this could spark the end of the Euro as we know it. Oh, and markets would get butchered, of course.
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The DAX enjoyed a good ride on a very favorable trend this week, even touching the 6,000 threshold twice, and ended at 5,967 last Friday. As the Slovaks have given their okay for the EFSF fund, a real solution for Greece starts to look feasible. Even further rating downgrades by S&P could not harm momentum. Over the weekend, the G-20 ministers have met in Paris to discuss the crisis and France’s ECB board member Christian Noyer ruled out any further Eurozone defaults beyond Greece.
However, it seems far to early to start cheering. Politicians all over the world are now playing the blame game. While Hillary Clinton did not forget to mention the problematic partisan paralysis in Washington in her speech at the New York Economic Club, she clearly put the blame for the week US economy on China for not appreciating its currency.
Meanwhile, European politicians try to jump on the bandwaggon of people protesting against the perceived flaws of the international banking system. EU boss Barroso wants to restrict bankers’ bonus payments until the respective banks have upped their reserves. Germany’s finance minister Wolfgang Schäuble wants private investors to shoulder a larger part of the Greek default. And Sigmar Gabriel, head of Germany’s Social Democrats, even said the “ideology” of free markets has failed. Is the end nigh?
Hardly so. Even the German mainstream media like Der Spiegel are aknowledging that the politicians’ new appitete for bank-bashing is a lame manoeuver to divert people’s attention away from political failures of the past. States have spend too much, for too long, in the EU in particular. As a result, long-term debt is not in line anymore with the long-term prospect of a stagnating or even shrinking population in the EU.
The only feasible solution is either to spend less (so the economically challenged will protest) or to tax more (so the economically successful will protest). In the end, politicians might opt for a compromise: spending less, while taxing more. Now this will send the whole electorate cheering! By bashing the banks, politicians can pay their lip-service to structural reform by announcing that they have tried to tame the financial beast, albeit to no avail.
In the end, any sober politician knows that a properly working economy needs a functional financial sector. Everything else is much ado about nothing, no more than a populistic scheme like in 2008. Nevertheless, bankers would be well advised to stay out of the line of fire and to tone down a bit. Once we have a draft on a Greek default, everybody will be happy and the protesters’ fires will soon be extinguished. Until then, finanical stocks are looking highly volatile and prone to public overreaction.
With the German release calendar featuring both the ZEW (on Tuesday) and the ifo indicator (on Friday), markets are bound to set their course for the upcoming earnings season. After the good performance of the past two weeks, the DAX could easily get knocked down again on profit taking. In my opinion, only an unexpected rise in ZEW or ifo might prevent that.
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Germany’s benchmark index had a very volatile week, with financial stocks bouncing up and down on every piece of news on the European debt crisis. In the end, the DAX managed a weekly gain of about 3% — enough to establish a temporary upside trend which could last until 5,800. However, the short-term downside potential is still there, given the current fears about a new credit crunch in the Eurozone, albeit France and Germany tried to talk down the risk over the weekend.
Royal Bank of Scotland saw their Moody’s rating being cut by two notches, but the ratings of eleven other UK banks, along with Portuguese and Italian financial institutions suffered as well. Meanwhile, Fitch downgraded its sovereign ratings for Italy and Spain on Friday, with even the Aussie taking the toll in early Monday morning overseas trading. Franco-Belgian lender Dexia, in the meantime, looks as if it will be getting dismantled. Is this a new Lehman-style incident, after all?
I would doubt it. Once the European rescue funds EFSF will have been implemented in its planned form by the middle of the month, the Greek crisis will look like peanuts. The EFSF then has ample funds available to refinance Europe’s ailing banks, if there will be ailing banks at all (anyone remembering the latest stress test?). A big chunk of the Greek debt is now held by the ECB and by European governements anyway. The fear of a credit crunch looks like a clever diversion from the EU’s financial magicians to pull their trick. With the EFSF fully operational, the Eurozone has a financial sledgehammer at its command, ready to push down any further market notions on governments who might not be able to repay their debt.
The EU debt spiral can keep turning then — with the ECB standing on the sidelines to inflate debt away, if necessary. Sure, this policy isn’t in the ECB’s founding statement. But buying government bonds wasn’t their, either. This may be a dangerous game (see our comment) but European politicians seem wiling to take the risk in order to keep their treasured Eurozone up and running.
The real risk, hardly spoken about in the mainstream media, is still the cooling economy. Germany’s industrial production remained quite robust in August, but factory orders saw an unexpected decline. And the reassuring US labor market data were partly based on formerly strike-bound Verizon personnel going back to work.
The German release calendar is quiet this week, apart from the trade balance data on Monday morning and the third quarter earnings sesaon is still two weeks away. Markets will therefore likely cling to the latest news about a credit crunch that may never evolve. The Dax has been called 2% lower over the weekend. Keeping this in mind, we should be prepared for a bouncy opening this week.
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