By Claus Vistesen, on December 2nd, 2010
There aint nothing as a good short covering/melt-up rally day. The market has been in a flux the past weeks, but yesterday’s move proves, I think, that the upside surprise is much stronger than the downside and that the equity still wants to grind higher unless the world really(!) falls apart. On the flip side we are still some way below earlier highs and in this sense, it is very un-impressive. But the Bernanke put is very strong here. Good economics data at the zero lower bound is consequently completely cleansed of risk that it will lead to higher interest rate expectations since no one believes that Bernanke will raise interest rates anytime soon, nah strike that, ever!!
As FT Alphaville latches on to, the market is now trying to play the same game of chicken with the ECB and this time, the stakes are higher. Basically, you want higher equities we can deliver, but if you disappoint we will huff and puff your pretty little house down and all those small piggies will be left without shelter. So, does the ECB plan to deliver then. Well, it seems to be a good idea to cover any short on that prospect alone but on the other hand, Trichet et al would be prone to sticking it to the market just for the sake of it even if the macro backdrop leaves them with the last policy option available.
So, lads and lasses … make your bets!
By Eldon Mast, on July 1st, 2010
Negative moods in Europe are finally being calmed by news on Wednesday that the European Central Bank will likely lend less money than expected for the next three months. The data suggests that region’s banks’ cash needs were wildly overblown again by the crisis fear-mongers.
“The result of the ECB’s money market operations indicated that money markets have been less distorted than originally feared,” BNP Paribas said in a note. BNP Paribas is considered the leading financial group of the eurozone.
Also providing a hopeful sign, Germany’s unemployment rate declined to 7.5% in June thanks not only to the traditional springtime upturn, but also an improving economy, according to the country’s labor agency report. They released data showing that the jobless rate was down from 7.7% in May.
The German data raised hopes on Wednesday that consumer spending in Europe’s biggest economy will help the region, a zone where doomsters have suggested that severe spending cuts will darken the growth outlook.
The European reality now mirrors what most analysts now recognize in the U.S. economic prognostications. “The U.S. economy has stabilized in the near term,” said Castor Pang, director of research at Cinda International. “Maybe the U.S. markets are overreacting a little.”
By Claus Vistesen, on May 17th, 2010
If an ECB in QE mode, €60 billion in cash, €440 billion from a pooled EMU effort and €220 billion from the IMF only lasts a week, then I’d humbly submit that we have a problem.
(Screenshot from Bloomberg, click for better viewing)
It is difficult to say whether it was former Fed chairman Volkcer’s comment on Euro breakup which set alight the initial fire, but what is certain is that it does not seem that markets have calmed down. And they shouldn’t be. The package may be impressive, but the growth prospects of the Eurozone has now been moved down more than a couple of nudges and still there is looming and large risk that debt restructuring will come eventually (I believe so for example).
As ever, I should point out that in my world slumping stocks do not constitute a problem as such, but volatility is rising and with it, risks of a veritable rout against which it is difficult to see where policy makers will find the tools prevent a sea of red turning into severe bloodletting.
By Claus Vistesen, on May 14th, 2010
As we are about move into the fourth day of the week where EU policy makers together with the IMF and the ECB launched an unprecendented series of aid tools to combat the mounting risk of a collapse in Greece and elsewhere in the European periphery I am finally ready to move in with some comments. First of all, there has been no shortage of comments, opinions and market calls on the back of the bailout package and while risky assets have indeed rallied, it is if the underlying reality of the situation looms ever more prescient underneath the surface than what one would have expected from such a collosal dose of stimulating policy.
And for good measure, let us re-cap the list of stimulating efforts taken by Europe and the IMF based on, no less than, Macro Man’s last post as a financial blogger;
* €60 billion in cash from the European Commission, funded by bond sales
* €440 billion in loan guarantees, via pooled support of member governments
* Up to €220 billion from the IMF
* Outright bond purchases from the ECB, to be sterilized (this has evidently already started)
* 3m and 6m full-allotment LTROs
* Reactivation of FX swap lines
This is an impressive laundry list if there ever was one and among the points is the very, very interesting u-turn at the ECB which will now, albeit sterilised, be buyers of real assets. This last change of policy and the effectual skydive by part of the Trichet and his accomplished out of the ivory tower may be what eventually clinches it for Europe. Together with the most recent news this week that Portugal and Spain now seem to be getting the message in the form of introducing some very own austerity measures of their own (which as the song goes are of course complete voluntary and preemptive [1]) this might just be the combination of policy moves that Europe needs to see this through without a nasty default of a further intensification of the crisis.
But then again, it might not. I am sceptical here although I concede that if it is backed up by serious and real measures to rein in deficits I might just be turned into a believer here. However, there are some things that still bugs me.
Firstly, it should not escape us here that what our dear policy makers effectively are doing is to fight fire with fire. More debt will thus be substituted with even more debt and it is not clear just what the end game is supposed to be. However, one thing which is now crystal clear to me is that if there is any way that the EU and the Eurozone are to make out of this in one piece it will mean a much tighter coordination of fiscal policy. This will require a monumental rethink of the EU setup and while I believe that the joint effort of EU policy makers could indeed be pooled to make this happen the chance of it actually materialising is slim. In this sense it will be interesting to see what exactly it will mean for the fiscal coordination (if any) that Eurozone economies are now jointly asking the market for funds to pool in that loan guarantee entity.
Secondly, the introduction of implementation of all these so-called austerity measures are not linear and we can’t feed them into linear models and expect these models to come up with usable results. In this sense, and abstracting a minute from the general risk of doing too little too late, the road ahead is very difficult. On the good side it now appears that Spain and Portugal have awoken to the fact that they too need to turn on the screw and that what ultimately distinguishes them from Greece is merely market timing. This is universally good news, but it this is only the statement of intent. In fact, before we close the book on 2010 this is all we are going to see since the 2010 budgets (already passed) are thoroughly in the red. The biggest problem here is simply that for all the good intentions in various EU commission and IMF proposals the actual process of implementation on the ground may proove near impossible. And here I am not talking about some innate laziness or non-voluntarism by part of the Greek, Portuguese and Spanish people; I am simply talking about the near impossibility of letting the entire burden fall on internal price and competitiveness adjustment from within an fixed currency union, but this of course has been the main issue all along. As I noted in another context, any state can only take so much of having to fight its own citizens with water and teargas week in and out even if they are trying to do good.
The considerations above have slowly, but surely convinced me that while I support the efforts by EU policy makers (both in spirit and in terms of the technical measures) I have increasingly converged on the idea that some form of debt restructuring in Greece (and possibly elsewhere in EMU) has to be included in what we could call the main scenario going forward. In coming to this conclusion of course, I am met with formidable resistance.
Take for example the IMF’s communiqué on the situation in Greece and why a debt restructuring would be a very bad idea (see also Emmanuel’s take).
Restructuring debt would not help Greece’s capacity to grow. The type of fiscal and structural reforms being put in place under the Government’s program are designed to do that – to bring down costs, to make the labor market more flexible and to improve the business and investment climate.
The web of economic and political inter-linkages—including that Greek bonds are held by a wide variety of private investors and public entities—severely complicates alternatives to the program the government has put in place. Any perceived positive near term effects of a debt restructuring need to be weighed against contagion effects.
Most of the adjustment in Greece is needed to eliminate its large primary deficit (the deficit net of interest payments). This is the main issue for Greece, not the level of the debt.
My main problem here is simply I think the IMF misses the main point by a mile. It is thus exactly the combination of too high interest rates and negative nominal growth rates (deflation) which make the situation in Greece unmanageable and also why I believe it was a mistake not to include some form of hair cut on Greek sovereigns (up front) as part of the Sunday’s shock and awe move. Now, I don’t dispute the point that the fiscal and structural reforms wouldn’t help, but the numbers just don’t add up. Greece is currently running a fiscal deficit to the tune of 12-15% and even if we assume that this will come down during the envisioned horizon Greece will still be caught in a debt trap once we are done. For a lack of a better comparison, Greece will come to resemble the Baltics and trust me, this is not a comparison you would like to be branded with. In this way, it is in fact the level of debt that will eventually force a debt restructuring in Greece and it will do so exactly because the terms with which Greece is about to embark on her structural adjustment are unsustainable from within a monetary union.
This brings us to the newfound QE profile by the ECB which could, in theory, make a lot of the problems of Greece (and Spain and Portugal) go away. However, we are alo moving into uncharted territory here. Consequently, echoes from Japan are coming closer and it is not altogether clear how the ECB would deal with the fact that it would have to permanently [2] massage the yields of Greek sovereign bonds in order keep the boat afloat. I emphasise permanent here since there is a real risk that the ECB has now decisively had its Japan moment and should the ECB commit to unwavering support for the Eurozone periphery it would not be a misnomer to dub the Eurozone Japan 2.0.
Among the long list of comments and analysis that has so far been ditched up to provide a view on the situation, I think that the one by John Hussmann comes very close to an adequate picture of the situation where you will forgive me, I hope, the following lenghty quote;
Looking at the current state of the world economy, the underlying reality remains little changed: there is more debt outstanding than is capable of being properly serviced. It’s certainly possible to issue government debt in order to bail out one borrower or another (and prevent their bondholders from taking a loss). However, this means that for every dollar of bad debt that should have been wiped off the books, the world economy is left with two – the initial dollar of debt that has been bailed out and must continue to be serviced, and an additional dollar of government debt that was issued to execute the bailout.
Notice also that the capital that is used to provide the bailout goes from the hands of savers into the hands of bondholders who made bad investments. We are not only allocating global savings to governments. We are further allocating global savings precisely to those who were the worst stewards of the world’s capital. From a productivity standpoint, this is a nightmare. New investment capital, properly allocated, is almost invariably more productive than existing investment, and is undoubtedly more productive than past bad investment. By effectively re-capitalizing bad stewards of capital, at the expense of good investments that could otherwise occur, the policy of bailouts does violence to long-term prospects for growth. Looking out to a future population that will increasingly rely on the productivity of a smaller set of younger workers (and foreign labor) in order to provide for an aging demographic, this is not a luxury that our nation or the world can afford.
“Failure” and “restructuring” mean only that bondholders don’t get 100 cents on the dollar. We can continue to bail out the poor stewards of capital who voluntarily made bad, unproductive investments, and waste our future productivity in order to make those lenders whole, or we can turn the debate toward deciding the best strategies for restructuring existing debt.
I agree with all of the above and it echoes my general sentiment which is not that Europe is about to sink into a hole, but that a real hard look at the face value of the obligations in Greece and elsewhere is needed. Naturally, and as a counter argument to this point is the increasingly worrying barrage of numbers purporting to show the exposure of European and US banks to Greek sovereign bonds and indeed the bonds of the Southern Europe. No matter where you look, the numbers aren’t small and it does not take a lot of imagination to see how this could very easily turn into a Lehman 2.0 moment for banks and thus the real economy. The only problem this time would be that we would be, for the most part, all out of firepower. It is important for me to point out that it is not because I discount this event too easily that I am calling for a preliminary look into debt restructuring. It is simply because I believe that with the current road map, the end game is given in advance. This won’t of course make the exposure any less grave, but did we really think that a haircut on the debt could be avoided here?! Especially, if we are talking about banks playing the funky chicken on the short end of the Greek yield curve (is there any other?!)by sucking up liquidity in Frankfurt only to park it a couple of thousand kilometers further south, then it really escapes me if people had seriously imagined that this would not unravel at some point.
We all know that it will be a regime change when the first OECD economy pushes the restructuring button, but it was bound to happen at some point. I’d thus recommend that we stopped kicking the can down the road and in stead picked it up and threw it away; only in doing so will be able to say that we are indeed still standing.
—
[1] – This is pooh-pooh of course, but as long as they believe it themselves I am happy to indulge them.
[2] – Let us say for 10 years to begin with.
By Eldon Mast, on May 11th, 2010
“The message has gotten through: the euro zone will defend its money,” French Finance Minister Christine Lagarde told reporters in Brussels early Monday.
With massive resolve after a 14 hour meeting, 16 euro nations agreed to offer financial assistance worth as much as 750 billion euros ($962 billion) to countries under attack from speculators. The European Central Bank (ECB) will counter negative and “severe tensions” in “certain” markets by purchasing government and private debt.
Marco Annunziata, chief economist at UniCredit Group in London, quickly released a statement following the ECB announcement: “This truly should be more than sufficient to stabilize markets in the near term, prevent panic and contain the risk of contagion.”
“I think they will have bought themselves a significant amount of time to do the right thing,” said Barry Eichengreen, an economics professor at the University of California, Berkeley.
“This sets a precedent for the rest of the life of the Central Bank and will have likely surprised even the most seasoned observers,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group. “The ECB’s intervention was necessary to short circuit the negative feedback loop…”
The swift and united action will likely now turn most eyes back onto the fundamentals of a worldwide economic recovery that is accelerating.
By Rok Spruk, on February 17th, 2010
Paul Krugman has blogged an interesting analysis of the anatomy of the recent economic crisis in Europe (link).
Europe’s difficult macroeconomic situation in the aftermath of the financial and economic crisis has exacerbated rising fiscal deficits and public debt alongside strong deflationary pressures. These pressures were triggered by the highly negative output gap – the difference between the economy’s potential output and the real output. In fact, a brief observation of the output gap estimates (link) shows that the sick men of Europe (Portugal, Greece, Spain, Italy, Slovenia) are likely to face negative output gaps. In 2010, Spain is likely to reach -2.12 percent output gap. Slovenia, Italy and Greece will also face a negative output gap. The negative output gap triggered strong deflationary pressures since the nominal aggregate demand is insufficient, causing a decreasing price level.
Before the financial and economic crisis of 2008/2009 evolved, Europe’s peripheral economies faced strong asset price bubble. As real estate prices were soaring, these economies attracted significant capital inflows which lead to inflationary pressures. Before the crisis, the inflationary dynamics in the peripheral countries of the Eurozone were strong. In Greece, Spain and Slovenia, consumer prices increased by more than 3 percent on the annual basis. The asset bubble was further spread by low interest rates. The asset price inflation in these countries was very high. In Slovenia, five-year asset prices increased by 500 percent (see: IMF, International Financial Statistics). As the increase in asset prices widened, Europe’s sick men were faced with rising current account deficit.
In 2007, Spain’s current account deficit amounted to more than 10 percent of the GDP. In such circumstances, a clever monetary policymaker would push up interest rates. As interest rates were at historic lows during the pre-crisis period, the real cure was on behalf of the fiscal policy. Before the crisis, Spain’s fiscal picture was very well indeed. From 2004 to 2007, Spain was running a fiscal surplus which reached the level of 2 percent of the GDP in 2006 and 2007. However, massive capital inflows were not sterilized by raising interest rates which further inflated the real estate bubble and overheating of Spain’s economy.
Independent fiscal policies and a common monetary policy – which is an economic model of the EMU – cause asymmetric shocks. During the years of high growth, these shocks are mostly neglected. However, during the crisis these shocks might cause a serious trouble in the macroeconomic adjustment. Greece, which recently declared a worrisome possibility of debt default, is a typical case of what happens when asymmetric shocks persist.
As Greece, Spain, Italy, Portugal and Slovenia now face high fiscal deficits and poor economic growth, these countries will likely face years of deflationary pressures and high unemployment. The fiscal policymakers already exhausted the ability of governments to boost spending. Further growth of government spending is impossible unless European countries want the Greek debt episode to evolve in a domino effect throughout the Eurozone. The ECB will sooner or later this year raise the baseline interest rates to avoid the inflationary swings in Germany, Austria, Netherlands and other countries with current account surplus.
The macroeconomic outlook for the Eurozone is backlashed by the debt crisis in Mediterranean countries. An economic recovery may include indepedent monetary policies to adjust interest rates and prevent another asset bubble episode as well as to target current account balance. However, European countries will have to rethink the role of indepedent and discretionary fiscal policies pursued by the sick men of the Eurozone.
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