The past week was supposed to be a rather calm one. Events unfolded relatively as expected with the exception of some developments in the Spanish and Italian banking sectors:
- PMIs delivered a grim picture of economic conditions in Europe, despite the hope that growth might be bottoming, bringing brighter days ahead.
- Germany led the Core of the Euro-Zone countries to push Greece for further commitments to austerity, while offering to adjust the Portuguese programme to relieve some of the pressure on the country’s economy and society.
- Spanish banks started looking for €50 Bn to shore up their balance sheets while Italian banks were downgraded by S&P following the sovereign downgrade
- The ECB refused an open and direct haircut to its holdings of Greek debt. However, its president, Mr Draghi, offered an alternative path of assistance to Greece through the payout of ECB dividends to its shareholders (national treasuries).
Below I provide a narrative that may shed some light into these developments.
Differentiated Eurozone – Bouyant Core Vs Lagging Periphery
PMIs -Markit Economics released Service sector Purchasing Manager’s Indeces (PMIs) for Eurozone countries as well as composite measures for the Euro-Zone as whole. The situation is rather differentiated between the core and the periphery. Businesses are not doing too bad in Germany and France while their Spanish, Italian and Greek counter parts are doing rather poorly. The fall in new orders is, in my view, particularly alarming and foresees some grim months ahead.
To add to this disparity, Germany released encouraging new trade figures for the period of January to December 2011. According to this report, exports grew by 11.4%, while imports grew 13.8%. The majority of trade (59% of exports and 63% of imports) continued to be conducted with EU partners, particularly with members of the Euro-Zone(39% of all exports and 44.5% of all imports). The largest growth (16.1%) was registered in imports from non-Euro-Zone EU partners and the lowest (8.6%) was registered regarding exports to the Euro-Zone.
Trade surplus, which grew by a robust 2% in nominal terms, performed even better(2.2%) in calendar and seasonally adjusted terms. The sovereign debt crisis continues to treat Germany well.
The same cannot however be said of Greece, Portugal, Spain and Italy. I believe this to be too insightful for the markets, but in my view this the only explanation I can come up with for why Belgian, German and French yields rose over last week. If the Euro-Zone does badly. If there are no new orders, in the long run, everyone looses. However this rise was relatively small, and may just be the result of normal market fluctuations.
Differentiated Eurozone – Assertive Core Vs Submissive Periphery
German Politics of Divide and Conquer – There were some interesting reports about Portugal and Greece, which I believe might be related. Although both Portugal and Greece faced protests, it would be wrong to put them on the same boat. Indeed, it seems that Germany has co-opted Portugal to allow more pressure to be put on Greece to abide by the austerity diktat.
Following the successful PSI talks, the negotiations the rest of the negotiations of the second Greek bailout continued. Here it is interesting to seeWith an austerity agreement by Greek politicians being rejected by EU partners who demanded more aggressive measures. The Greek finance minister, Mr Venizelos, was then forced to return to Greece and beg his fellow countrymen to support the more austere plan put forth by the troika which demands a cut to pensions worth €325 Mn to accompany the PSI agreement, in order for Greece to receive €130 Bn of its second bailout. The tone has now changed to imply that a refusal to comply will push Greece to leave the Euro-Zone. The argument is, legally, completely vaccuous, but the rhetoric is telling. As the Core’s banks have probably shed their pounds of Greek exposure, its political leaders seem to have become more assertive towards the periphery. In this sense, the reported comment of Mr Juncker, prime minister of Luxembourg, are quite telling. The federalist leader was quoted as saying
“We need to see these commitments in the coming days. (…) It is simple and easy – the Greek parliament will not reject the package.”
This arrogance and authoritarianism will inevitably beget resentment and defection, potentially leading to a potential breakdown in political relations with Greece. This is dangerous because the name of the game continues to be “contagion”.
However, this behaviour does not arise in a vacuum. Although I am not a fan of conspiracy theories, it seems to me that Germany has a plan. In parallel to the extremely tough handling it is giving Greece, it is also extending an accommodating hand to Portugal. After Reuters reported that Portugal was “sounding out advisers on debt restructure” on February 2, Der Spiegel published an article, on February 10 reporting Mr Schäuble saying that if “there would be a necessity for an adjustment of the Portugal (program), we would be ready to do that”. However, according to that article “Schäuble made clear that the Portuguese aid package could only be revisited once a ‘substantial decision on Greece’ “.
Of course one could argue that the situation in Portugal is not the same as in Greece, which it isn’t. One could argue that Portugal has behaved well and proactively, while Greece has been a deceptive and unreliable partner, and that therefore the Portuguese deserve Germany generosity while the Greek do not. I recognise all of this, but my point still holds: German generosity to Portugal is linked to Portuguese (tacit) support of the Core’s demands of further austerity in Greece. If Portugal walks the line, it gets help. If not, not so much. It might have been a coincidence, but I wonder whether this explains the relieving dive that Portuguese sovereign bonds experienced on Friday. Very Machiavellian…
The ECB’s Greek bail in: Myth and Reality
In parallel to the noise about the Greek negotiations discussed above, the internet was filled with reports and comments that the ECB would intervene by accepting to take a haircut in its holdings of Greek debt. There was talk of two different possible paths, which I had discussed at the end of a previous post. The Wall Street Journal even reported and analysed the consequences of this deal. However, it was not so, with Mr Draghi telling reporters during Thursday’s press conference that:
“All the talk about the ECB sharing the losses is unfounded (…). The idea that the ECB could actually give money to the programme would violate the prohibition of monetary financing.”
However this stance does not completely strip the ECB of tools and processes to assist Greece. Indeed, the press conference ended on a not so vague statement that
“if the ECB gives money to governments that is monetary financing. If the ECB redistributes parts of its profit to euro area member countries (via the euro area national banks) according to its capital key, that is not monetary financing.”
Italian and Spanish banks
Finally, the Spanish and the Italian banking sectors experienced some turmoil. On February 2, Spanish banks were told to find a total of €50 Bn in profits and capital, by May in order to shore up their balance sheet and mitigate any losses arising from their exposure to a fragile housing market. If unable to do so, they were told to merge with other banks. The measure is being pursued to attempt to bring Spanish banks back to international credit markets. On Friday, February 10, six of the countries banks were able to find €11.8 Bn. Santander, BBVA, La Caixa, Banco Popular Español SA, Banco de Sabadell SA and Bankinter all had plans to handle it. If the Spanish sovereign rising yields are not caused by Greece, then I would say that markets are doubtful about their abilities. In Italy, S&P lowered the credit rating of 34 Italian banks, which for me is good enough an explanation for the rise in Italian yields.