 A run on the eurozone bond markets
Eurointeligence Comment and AnalysisAs the world focuses on the eurozone, this extensive analysis reminds us that the that the debt problem of the US government is at least as bad as that of the eurozone, and is likely to resurface very shortly.
The eurozone is now subject to a generalised and full-blown run on its bond market, as the crisis has now spread to France, Belgium and Austria. Italian spreads reached a horrendous 5.3% this morning, Spanish spreads are moving towards 5%, and French spreads, at 1.916%, are no longer at a level that this consistent with an AAA rating. Belgium’s spread has hit 3.2% this morning, and is now at a level of Italy and Spain a couple of months ago. Even Austria is now under attack, with spreads of 1.8% yesterday. It was a day when global equity market plunged, amid fears that the eurozone crisis could throw the world economy into recession.
It is clear now that the bond markets have called the eurozone’s bluff of the “leveraged EFSF” – a model that has now effectively collapsed. The persistent talk by officials about core Europe and break-up scenarios has added to the panic in the market.
Reuters reports that the eurozone’s strategy now consisted on a hope that markets would be impressed by the technical governments in Greece, where Lucas Papademos is expected to win a confidence vote today, and in Italy, where Mario Monti will present his cabinet today. But the market is unlikely to be impressed by these clearly foreshadowed events. On the contrary, the consensus view among market participants is that technical governments cannot be a solution to a political crisis. Investors are now hoping for a circuit breaker – which at this point can only come in the form of an explicit ECB lender of last resort status. Reuters quotes investors saying that the situation could quickly unravel within day in the absence of a circuit breaker.
France wants the ECB to end the crisis The ECB and the Germans thought that the idea of an ECB rescue operation to end the crisis was off the table. But they were wrong, as Francois Beroin told Les Echos. “We are in favour of an intervention of all European institutions including the ECB in order to bring the best answers to the crisis”, the French finance minister said in an interview. “The central bank, which is independent, has taken the engagement to be there in case of difficulties. Germany, for historic reasons, has closed the door to a direct implication of the ECB.” Baroin reminded his interviewers that the Fed, the Bank of Japan and the Bank of England all intervened to dampen the crisis without losing their independence. Asked about Bundesbank president Jens Weidmann’s repeated insistence that it was up to the governments to solve the crisis Baroin said. “We continue to think that the ECB is one answer and probably even an important element in this crisis. In the declaration of October 27 (the last EU summit) the ECB has committed to fully play its role in order to guarantee the stability of the eurozone. We have trust in that.”
Some even think about changing the ECB’s mandate
In yet another sign that France continues to push for the ECB to become the eurozone’s lender of last resort, Le Monde has a story about the clashes between Latin Europe (France and the South) and Northern Europe (Germany and the other Northern Europeans) about the central banks role. The paper writes that France and to lesser extend Germany had toyed with the idea that the ECB would intervene on the markets with the explicit aim of not letting the spread between the bund and other government bonds get beyond a certain threshold. According to Le Monde some even want to use the treaty revisions around the construction of a eurozone government in order to change the ECB’s mandate (according to which the bank is independent and its principal aim is to guarantee price stability). “Nobody dares go down that road”, the paper quotes an advisor to Herman Van Rompuy, the council president who steers the treaty revision work. “This question is a real taboo in Germany.”
The crisis reaches core Europe
With the spreads of France and Austria rising steadily, the crisis now has reached core Europe, Frankfurter Allgemeine Zeitung writes. “The doubts that France will be able to keep its AAA rating, are ever increasing”, the paper writes. “Generally the market opinion prevails that the European governments are incapable of solving the crisis.” The only eurozone government bonds that seem to be exempted from this generalised distrust seem to the German bunds. For Patrick Artus, chief economist at Natixis, France is de facto no longer a AAA country. “Since October the German and French rates diverge”, he told Le Monde. “France has left the heart of Europe in order to join the group of southern countries. Today the big institutional investors de facto give France an AA rating.” Artus is convinced that France will need a third austerity package on top of the two packages decided in the past few months in order to keep its deficit obligation this year and to get it down to 3,0% by 2013. But Francois Baroin tells Les Echos there will be no third austerity package and that France will manage to get its deficit down even if growth in 2012 will be only 0.5% as opposed to 1.0% which is the government’s current growth projection for next year.
Top economists all urge the ECB to act
Financial Times Deutschland asked world renowned economists like Dany Rodrik, Barry Eichengreen, Raghuram Rajan, Jean-Paul Fitoussi, Thomas Straubhaar and Dennis Snower how to react to the eurozone meltdown and their unanimous answer was: Only the ECB to stop the collapse of the currency union.
Greek growth will much worse than -5.5%
The data look even worse than the worst estimate – and they underline the bankruptcy of the EU/IMF’s strategy towards Greece. Kathimerini reports that the Greek economy shrank by 5.2% during the third quarter. This means that the 5.5% target is now virtually impossible to attain. (We assume these data are either annualised or relative to the previous year. They cannot be quarterly rates.) It is clear that such figures are inconsistent with the target of a 5.5% contraction for the year, given that the fourth quarter pressure on the real economy is likely to be even stronger.
The next loan tranche remains in doubt, as New Democracy leader Antonis Samaras continues to refuse to sign a letter that he supports the Greek adjustment programme. The European Commission yesterday reconfirmed its commitment not to release the next tranche of the loan until he gives a written assurance.
Growing irritation across the Europe against “Merkozy”
Le Monde and Les Echos both run stories about an increasing irritation across Europe against what many EU countries perceive as an attempt by Angela Merkel and Nicolas Sarkozy to run the eurozone and to split the EU 27 in ins and outs. “You can feel the exasperation in all the capitals of countries under a rescue program or those who fear that they will have one, as much as in those countries who are doing efforts unheard of like the Netherlands or Finland”, Le Monde writes. “But there are also the European institutions that are ill at ease with being transformed into a simple secretariat”. Les Echos insists that especially Italy and its new prime minister, Mario Monti, are upset with what they perceive as overly intrusive efforts by Sarkozy to be seen as the European crisis manager. The French president had toyed with the idea of going to Rome together with Angela Merkel right after Monti officially became prime minister. He was discouraged by his Rome ambassador who told him that the Italians were sick of being lectured about fiscal rectitude by Sarkozy under whose watch the French debt had risen 41% while the rise in Italy during the same time was only 19%.
Martin Wolf on what Italy has to do to stay inside the eurozone
Saving the eurozone, and saving Italy’s position inside the eurozone, is going to be a momentous task. Martin Wolf has this to say on Italy:
“… [W]hat Mr Monti must do is enormously tough. As Gavyn Davies argues, Italy might need to tighten fiscal policy by more than 5 per cent of gross domestic product, to reverse the widening spreads and start bringing gross public debt down from its exalted level of over 120 per cent of GDP. Given the inevitable adverse effects on output, the attempted tightening would have to be greater than this. Yet investors are unlikely to regain confidence in Italian debt if its economy does not recover. Austerity is not enough.”
The initial effect of the proposed reforms will shake confidence. Given the weakness of domestic demand, Italy will need export-led growth, which in turn will require labour-shedding and falls in nominal wages. The chances that this might succeed are not very high. Wolf concludes:
“The time for too little too late has passed. What is needed, instead, is ‘too much, right now’”.
Spreads, Forex, and ZC Bonds
This is what a generalised run looks like. To be continued, no doubt.
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