 Debate turns full circle with Monti’s proposal of ESM bond purchases
We are now back to some really old ideas, like using the rescue funds to buy bonds in the secondary markets. Mario Monti mooted this idea, as reported in detail in Corriere della Sera this morning, whilst simultaneously trying to insist that this had nothing to do with Italy. The idea is to use this facility for countries that have complying with the rules. The article says this idea would be discussed at the mini-summit in Rome, by Monti, Francois Hollande, Angela Merkel, and Mariano Rajoy. The idea won the immediate applause by Hollande and Rajoy, but Merkel was cool and non-committal. At the G20 summit in Los Cabos, Mexico, Barrack Obama declared that the Europeans finally got the message that they had to do something. Suddeutsche Zeitung reports this morning that a German government spokesman specifically denied that Merkel had accepted the proposal. Merkel had also rejected the idea of a common bank deposit insurance scheme. (Given the scale of the problem, and the agreed borrowing limits of the EFSF/ESM, the idea makes little sense unless it was accompanied by an ESM banking licence, as the sums involved could easily bust the budget. We also find Monti’s attempt to drive a wedge between Spain and Italy, and the programme countries disturbing. Monti wants support but without the troika. The same is true in Spain. That smells of a special rule for large countries, and will almost certainly be resisted by the small countries. Once you go down the route of a secondary market purchases, one would probably need to rethink the entire setup.)
Is the eurozone about to make a U-turn on austerity? Obama gave a very optimistic message at the Los Cabos G20 summit. El Pais quotes a senior US official as saying that the eurozone leaders had finally understood the severity of the situation, and had agreed to do more. He said they had agreed on a two-pillar strategy: policies to boost growth in the short-term, and to have austerity later. (What did they tell the Americans? Did they just want them to shut up? Or did they really change course and agree on a relaxation of fiscal targets, and a return to stimulus policies?) The final communique also made a reference to further integration of Europe’s financial architecture, involving banking supervision, bank recapitalisation and deposit insurance. Spiegel Online made the point that this commitment may be vague, but by putting it on paper, the eurozone leaders have now raised expectations, which they must fulfil.
The eurozone crisis hijacks the agenda at the G20 at the expense of others
Reuters has the story that anti-poverty groups complained that the eurozone had hijacked the G20 development agenda, pushed into the background its work on poverty and food shortages. It quoted Oxfam saying: “Leaders were absorbed with disagreements on how to fix the euro zone and lost sight of developing countries reeling from aid cuts, climate change and volatile food prices.” Food security was meant to be a priority during the summit, but leaders failed to come up with a plan. Another action group complained that while the final communique included some warm words, there was no action plan, or benchmarks, on issues like nutrition, corruption, and agriculture.
Can the ECB bail out the eurozone again? As we approaching an EU summit with no obvious efforts yet again to resolve the crisis, analysts are trying to scrape the barrel for ideas of what might be possible to save the euro. What everybody seems to come up with is either another LTRO (which is insane, given that it would deepen the interdependence between banks and their sovereigns), or a resumption of ECB debt purchases on a much larger scale. In a news analysis, Reuters quotes David Mackie of JP Morgan as saying: “A successful exit from the euro area crisis will require both a road map to a fiscal and banking union and a much larger ECB balance sheet…But while what is needed seems increasingly clear, the risk is that policymakers continue to move incrementally.”
Meanwhile in Spain…
The bond auctions did not go well. Spain had to pay an interest rate of 5.074% for a 12-month treasury bill, compared to an average yield of 2.985% at the previous debt auction. This auction raised €2.4bn. The average yield on the 18-month T-bill was 5.107%, which raised €639bn. There is more to come tomorrow with auctions for longer-dated debt. Spanish ten-year yields remained broadly unchanged, at around 7.3%, but the spread fell due to an increase in the yield of the bunds. At these levels, Spain’s position is unsustainable, especially as the country is falling into a deep recession.
Wyman and Berger to propose €75bn in recapitalisation
We think this figure is too low because its worst case scenario of a total 5% output drop in 2012/2013 is too optimistic. The external consultants Oliver Wyman and Roland Berger will give their final verdict tomorrow, but El Pais reports that the figure they are like to come up with is €75bn, which remains below the €100bn ceiling agreed by the EU finance ministers. The article says that the auditors have been visiting individual institutions to tie up loose ends, and get a clearer picture about specific provisions. Spanish bankers have complained that the external advisers have been using Bankia as a benchmark to set write-offs, as Bankia’s property portfolio is of much lower quality than the average. (The recapitalisation requirements will depend critically on the path of the Spanish recession. We believe that Spain will see a prolonged output drop, which is more pessimistic than the auditors’ most pessimistic scenario.)
Hedge fund managers are betting against German bunds
This story from the FT should come as no surprise. It says that leading hedge fund managers were betting on a sell-off in German government bonds after the recent capital-flight induced rally. More than 50% of hedge fund managers polled in an industry conference said they expect bund yields to double within the next year. The article quoted Gavyn Davies as saying every analytical model was signalling that German bunds are too expensive. The view is also shared by Bill Gross of Pimco who said there were few scenarios under which bunds would perform well.
German constitutional court strengthens right of the Bundestag This message caused some temporary excitement yesterday, but its implications are limited to Germany only. The German constitutional court accepted a complaint by a member of the German parliament according to which the government had not consulted sufficiently with the Bundestag in the negotiations about the ESM and the Euro-Plus pact, Frankfurter Allgemeine Zeitung reports. The court said the government needs to involve the parliament in all future negotiations. The ruling won’t affect the ratification of the ESM and the fiscal pact.
Greek government – not quite there yet Greece is moving closer to a coalition deal but concerns within PASOK and Democratic Left have held up the process, Kathimerini reports. PASOK leader Evangelos Venezelos is opposed to the participation of high-profile PASOK figures in the government, a position challenged by some of PASOK’s heavyweights. Fotis Kouvelis also faces an inner-party conflict over how actively his party should be involved in the coalition. Late Tuesday night, Kouvelis told his party’s central committee that they would not provide any personnel for the government but would support the coalition in Parliament. The three party leaders are expected to hold their final talks on Wednesday.
The cabinet – some name tossing Samaras looks certain to become prime minister and Kathimerini reports that he is to favour Vassilis Rapanos, the president of National Bank, as finance minister. Samaras is also considering the appointment of Christos Staikouras, an ND deputy and economics professor, as deputy finance minister in charge of revenues. The head of the IOBE think tank, Yannis Stournaras, is also being touted for a role in the new administration’s financial team.
Venizelos calls for a Greek delegation to discuss austerity progress to Brussels
PASOK leader Venizelos has proposed that a team could travel to Brussels every three months to discuss the details of the fiscal adjustment programme, thereby avoiding the quarterly inspections by troika officials in Athens. PASOK officials have suggested that Nobel Prize-winning Cypriot economist Christopher Pissarides could be appointed to head this negotiating team.
EP voted for diluted draft legislation on credit ratings The European Parliament Tuesday voted through draft legislation to tighten rules on credit rating agencies. The new rules aim to reduce investor reliance on ratings and restrict the scope for conflicts of interest. Reuters reports that an initial plan for an across-the-board requirement for companies to rotate ratings agencies every three years was weakened to apply only to securitizations and other kinds of structured finance, and the period increased to five years. The stance brings the Parliament’s position largely into line with that of EU national governments. As both the European parliament and the European Council have now agreed a negotiating position on the rules, three-way discussions can begin with the European Commission on the final wording of the legislation.
An example of the economic illiteracy in the German debate The FT carries a screaming oped by Joseph Joffe, which we would not normally refer to, except this time as a demonstration of the extraordinary degree of economic illiteracy in the German economic debate. He tries to make the point that there is no such thing as austerity in Europe, because things are not nearly so bad as they were under Brüning. Then he says, without proof, that QE would produce inflation. And on exchange rates: “When the euro was born, it fetched $0.85; last year it climbed to $1.49. Yet German exports boomed. The moral of this tale is competitiveness was encouraged at home through labour market, tax and welfare reforms – measures that Club Med refused to implement.”
A choice between soap opera and tragedy Martin Wolf’s column in the FT looked at the position of Merkel, whose speech in the Bundestag he summarised as: Germany is not about to put up more money; the eurozone must become like Germany; Germany will only accept a further loss of sovereignty in the presence of strong rules and credible controls. He says the consequence is more austerity in the periphery, and low growth for the foreseeable future. He says the crisis threatens to become a long-running soap opera – or a tragedy.
10-Y Spreads, Forex, ZC Swaps and Euribor-Ois Bund yields spike after the report from the hedge fund conference.
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