This blog contains Gavyn’s initial response to the eurozone summit. As more news emerges, he may add further comments below if his assessment changes during the weekend.
In the wake of yet another summit, we need to ask our usual question: is this the eurozone’s game changer, or in football parlance the “Balotelli moment”? Clearly, there have been some late night concessions from Germany, which could turn out to be very significant in the long term. Spanish and Irish debt ratios will markedly benefit as the costs of their bank bail-outs are removed from the sovereign balance sheets and absorbed by the eurozone.
The markets have welcomed these developments, and rightly so. In particular, the opening sentence of the statement, which says boldly and simply that “we affirm that it is imperative to break the vicious circle between banks and sovereigns”, could prove to be a major breakthrough. Some think it might be the beginning of a Euro-tarp.
But my fear is that, as so often in the past, the devil will prove to be in the detail. The more carefully one examines the text of the statement, the more questions are raised about how the proposed measures will actually work.
In particular, it is debatable whether there are any terms for direct eurozone recapitalisation of Spanish banks which will be acceptable both to the Spanish government and to the German Bundestag. (The latter will be empowered to “monitor” the new arrangement, according to Mrs Merkel’s spokesman.) And the shortage of remaining funds in the EFSF/ESM, which I discussed here last week, has certainly not been solved. Read more
Gavyn has made some changes to the presentation of the table due to readers’ comments summarised in the footnote. The argument is not changed.
Another week, another summit. Once again, we are being told, this time by Italian prime minister Mario Monti, that there is only one week left to save the euro. Yet the crisis still does not seem sufficiently acute to persuade eurozone leaders that a full resolution is necessary.
The next summit on June 28 and 29 will unveil a long term road map towards fiscal and banking union, which in better economic circumstances could appear highly impressive. But the market is currently focused on the shorter term. Unless there is some form of debt mutualisation at the summit, resulting in a decline in government bond yields in Spain and Italy, the crisis could rapidly worsen.
Debt mutualisation can come in many forms. The European Redemption Fund, proposed by the Council of Economic Experts in Germany (and discussed here) seems to have receded into the background this week but could still have an eventual role. More immediately, the main option on the table seems to be the use of the eurozone firewall (ie a combination of the EFSF and ESM) to buy secondary government debt, or inject capital directly to the banks. But the problem here is simple: a lack of money. Read more
As the eurozone crisis enters a critical phase, market attention is once more focused on the central banks to contain the crisis. They have promised in advance to provide unlimited liquidity to solvent financial institutions if necessary in coming weeks, which is now their standard response to financial shocks. However, the slowdown in global activity caused by the euro crisis may mean that they are thinking of acting more aggressively than that. A further large bout of unconventional easing is now on the agenda. Read more
The failure of the Spanish bank bail out to improve market sentiment this week is disappointing. The markets have chosen to focus on the fact that the bail-out will add to Spain’s government debt, which is increasingly being viewed as unsustainably high. The spike in 10 year Spanish bond yields to over 7 per cent yesterday has demonstrated that new forms of “burden sharing” for government debt are needed at the summit on 28/29 June.
Chancellor Merkel once again appeared to dash these hopes on Thursday by ruling out the issuance of eurobonds, and a eurozone bank deposit guarantee scheme. She is willing to contemplate these reforms only after further constitutional moves in the direction of fiscal union, which might take years to achieve. However, there are two reasons for thinking that the German position might turn out to be be more flexible than it seems. Read more
Spain’s decision to apply for eurozone assistance to recapitalise its banking system removes one of the key structural weaknesses which has undermined confidence in the euro for many months. Until now, successive Spanish governments have repeatedly claimed that there was no need for eurozone assistance for their banking sector. However, these claims have not carried much credibility since the economy dropped back into recession last year, taking the real estate sector down with it. (See earlier blogs here and here.) The failure of Bankia was the final moment of truth. Read more
The weakness of global equities and other risk assets in recent weeks has clearly been driven by the deterioration in the eurozone crisis, but that has not been the only factor at work. There has also been concerted weakness in economic activity indicators in all the major economies, while the central banks have been sitting on their hands. That is never a good combination for asset returns.
This week, however, the markets’ hopes have been rising that the major central banks are once again preparing to ease monetary conditions, if not via a formally co-ordinated announcement, then in a series of separate steps which would amount to a powerful monetary boost to the global economy. Although this policy change may take a couple of months to transpire, it does indeed seem to be on the way. The pause in monetary easing which became clear in February/March has once again proved to be only temporary. Read more
A few weeks ago, after the Greek election on May 6, a consensus developed among many macro investors about the likely path for the eurozone crisis during the summer. This consensus held that Greece would leave the eurozone in a disorderly manner; that this would cause severe contagion problems for the Spanish and perhaps the Italian banking system; and that the ensuing mayhem would finally force the Germans to permit a full resolution of the crisis, probably via a massive further use of the ECB balance sheet. This was held to be an “optimistic” scenario for global risk assets.
This consensus has since frayed at the edges. Investors have realised not only that Greece may remain inside the euro for a further messy period, but that the condition of Spanish banks has spiralled out of control. This needs to addressed, whatever happens to Greece. Read more