In the week that that passed the Euro-Zone economy was marked by an emphasis (of the media and of analysts) on positive data releases, both in Europe and in the USA. On the down side, fruitless Greek PSI negotiations caused some tumult, mainly in Portugal. To a more uncertain degree, it is likely that ECB intervention in Spain, and possibly in Italy also, mitigated extremely bad unemployment figures. The consequences in the bond markets can be seen below:
Good News calmed the Markets
All countries finished the week with lower yields than they began, on all maturities, except for Portugal (all maturities) and Greek ten year bond yields. The fall in sovereign debt yields of most countries was most likely due to the European PMIs published on Tuesday (Euro-Zone, Germany, France), German business optimism seems to have overwhelmed poorer consumer confidence Wednesday. Finally, the GDP data from the USA was encouraging, even if it missed the 3% growth mark by 0.2 percentage points. The bank lending survey report published on Friday by the ECB was less encouraging, but despite the fear mongering of the media, this does not paint such a desperate picture either. The survey was conducted for December and most likely failed to account of the LTRO expansion that took place over Christmas 2011. More importantly, the lack of a market reaction to the extremely bad Spanish unemployment figures (22.85% in Q42011) either means that these were already factored in, which is possible, or that the ECB intervened, as it was reported it did in Italy.
Uncertain Greek PSI talks
In parallel to these developments, the Greek PSI negotiations between the IIF and the Greek Government continued to be inconclusive, with the media alternatively reporting encouraging progress and dramatic failures, which created uncertainty for Greece. Even now, Bloomberg still has 2 relatively contradicting articles about Greek PSI negotiations(“Private Sector Involvement”, e.g.: Debt renegotiations). One reports banking negotiators expect a deal by the end of this coming week, while the other reports the warnings of Josef Ackermann, the CEO of Deutsch Bank regarding the perils of default. It goes to show no one still knows where the wind is blowing and everyone is edging their bets. Even the media…
Portuguese consequences of a Greek PSI
Interestingly, fears of contagion from any fallout from the Greek negotiations seem to have only affected the Portuguese bond yields (on all maturities), rather than Ireland, Belgium, Spain or Italy as well. The result of Greek PSI negotiations will provide a template of either what to do, or what not to do, if the funding situation of all of the endangered countries above worsens, so it would make sense that all yields, rather than only the Portuguese one, would rise. Why this did not happen is difficult to know for sure, but here are some possibilities:
- Portugal is more similar to Greece than the others are. This hypothesis postulates that Portugal is closer to Greece than to say Ireland, both of which are small Euro-zone countries which have required a bailout. On the face of it, this is not at all unreasonable. Prior to the financial crisis, both Portugal and Greece (once adjusted for statistical fraud) had rather anemic growth and growing government debt, although Portugal to a lesser degree than Greece. They both have a similarly sized population, and specialise in the same unsophisticated products. Both countries are also highly centralised, which leads to flypaper effects. Both countries also have PR electoral systems and a unicameral parmliament, which means that MPs are weak and that the only checks and balances are offered by equally weak Presidents and Courts of Account. Finally both countries are also characterised by a level of rotativity so that parties change but policies generally tend not to. So there’s been a lot of moral hazard in both countries. Portugal clearly is not Greece, but at the same time it is similar enough that markets could indeed be putting them on the same boat. This can be seen in the image below, compiled by Open Europe.
- The hikes induced by the uncertain outcome of Greek PSI negotiations caused a shift in all of the other countries as well, but the ECB intervened. In my view, it seems likely that there is at least a bit of true in this argument. As I mentioned before it is almost impossible for Spain to have published such poor unemployment numbers without markets reacting to it. However, markets didn’t, at least not in a sustained manner. Therefore, I believe that it is extremely probable that the ECB intervened in Spain and if the occasion presented itself, in Italy as well. However, I believe that any intervention of the ECB is at least limited in its scope when it applies to the smaller countries, with a preference for Italy, Spain and probably Belgium. There are three reasons for why, if I were at the ECB this would make sense to me:
- The EFSF has enough money and the ability to intervene in the debt markets of Greece, Portugal and Spain, but not in those of Italy and Spain.
- Helping Spain rather than Portugal sends this message to market operators (who have the priviledge of observing the details of the ECB’ SMP operation. Portugal and Spain, although similar and interconnected, do not have the same systemic importance. Although it might be easier to help Portugal, helping Spain sends a more direct and clear message to financial markets, i.e.: Spain is in safe hands.
- The monetisation of public debt is perceived as an imposition on the mandate of the ECB and is only truly carried out as a last resource. Intervening in Portugal, because it has been bailed out and only needs to have access to the markets in 2013 (see page 36), is therefore redundant.
- Portugal had its own domestic negative developments, which the international media may not have picked up on but markets did. There are at least 3 such examples.
- First, there are reports, by the Portuguese weekly Publico, that supporters of the President are calling for the finance minister, Vitor Gaspar, an independent who was called in from his position as head of President Barroso’s economic advisers at the EC, to be fired. While they belong to the same party, the Prime Minister and the President have different power bases and do not depend on each other. To a large extent it is even possible that those “supporters” are misrepresenting the view of the President. This “call” would be supported by the perception that the ultraliberal policies of the finance minister are threatening the Portuguese welfare state. I doubt that in the present state of crisis it is possible for such a disagreement to topple the government. In any event it is debatable whether the Portuguese welfare state is being toppled at all, and if it is, whether it is no the result of decades of morally hazardous mismanagement. Finally. the President is aware of the popularity of the finance minister, in Brussels, Berlin and Paris.
- A second source of domestic political problems was the opposition of the leader of the country’s second largest labour union (CGTP) to the “Growth, Competitiveness and Employment Compromise” reached between the government, employers and the country’s largest union (UGT) on January 15. Again I find this unlikely to be the cause. Labour unions in Portugal do not have a huge influence. In my view, this is mostly due to the fact that there is very little membership, even if they represent a large segment of the labour force.
- Another, more obscure source of problems could be the ridiculous amount of money that has disappeared through the gaps of the Portuguese fiscal and monitoring system over the years. This week a member of the socialist party and a minister in the previous government, Jose Lello, admitted to not having declared Euro658.000. This is an endemic problem of the Portuguese state that I have covered to some extent in the past. I doubt however, that this had any influence at all on Portuguese debt market developments. If there were any sustainability concern caused by this issue it would have been found by the Troika by now (I hope). Moreover, the government has devised policies, which in my view, if well implemented, should address this moral hazard problem.
- Reuters reported that Germany wants Greece to give up budgetary sovereignty in order to be able to receive its second bailout. Whether this is true or not, is of very little consequence. Much like the proposed withdrawal of voting rights in the council, such a procedure could never be accepted by the 27 members of the EU. On such an issue. there will always be at least one that will say no. That’s a fact. The articles, without this comment are a wast of internet space, airwaves, ink and paper.
- On other, yet less relevant news, Fitch downgraded Spain, Italy, Belgium, Slovenia and Cyprus, and lowered France’s outlook. This was not extremely relevant because it followed S&P’s much more momentous downgrade on January 13. In ratings downgrades as with everything else, first-mover advantage matters.
- Finally, it was reported that the European Commission intends to impose losses on bond holders once the crisis is over.