MacroScope

No time for complacency

After a tumultuous fortnight where the European Central Bank, U.S. Federal Reserve, German judges and Dutch voters combined to markedly lift the mood on financial markets, we’re probably in for a more humdrum few days, although a raft of economic data this week will be important – a critical mass of analysts are saying that after strong rallies, it will require evidence of real economic recovery, rather than crisis-fighting solutions, to keep stocks heading up into the year-end.

A weekend meeting of EU finance ministers reflected the progress made, but also the remaining potential pitfalls. Our team there reported the atmosphere was notably more relaxed and Spain’s announcement that it would unveil fresh economic reforms alongside its 2013 budget at the end of the month sent a strong signal that a request for bond-buying help from Madrid is likely in October. If made, the ECB could then pile into the secondary market to buy Spanish debt  if required and hopefully drag Italian borrowing costs down in tandem with Spain’s.

BUT. The Nicosia meeting also exposed unresolved differences between Germany and others over plans to build a banking union. German Finance Minister Wolfgang Schaeuble said handing bank oversight to the European Central Bank is not in itself sufficient to allow the euro zone’s rescue fund to directly assist banks – another key plank of the euro zone’s arsenal. It sounds like that debate went nowhere. Having largely been the dog that hasn’t barked so far, public unrest is on the rise with big marches in Portugal and Spain over the weekend against further planned tax hikes and spending cuts.

And, putting further out risks such as Italian elections to one side, it remains to be seen whether euro zone policymakers have learned from previous mistakes when they took their foot off the gas each time the crisis hit a lull. It is noticeable that German officials are already telling anyone who will listen that a Spanish aid programme may well not be necessary given the extent of the country’s borrowing costs since Mario Draghi’s late-July declaration that he would do whatever it takes to save the euro. German Chancellor Angela Merkel’s setpiece news conference today could shed some light here.

Our working hypothesis has been that having put so much effort into shoring up Spain, the euro zone couldn’t conceivably let Greece drop, thereby plunging the whole lot of them back into crisis. That still holds true – Greece must get more time and/or money to meet its bailout targets. But Austrian Finance Minister Maria Fekter muddied the waters on Sunday,  saying Athens would get only “a few more weeks” and no more cash. Fekter has a track record as something of a loose cannon but if she’s right, Greece is doomed, and most importantly for the rest of the euro zone, doomed quickly.

There’s plenty to chew on over the week, notably Spanish, French and German bond auctions, Prime Minister Rajoy holding talks with Catalonia, Spain’s most indebted region, and fresh after elections which kept pro-European parties at the helm, the Netherlands’ 2013 budget plan will be unveiled.

Flash September PMI surveys for the euro zone, Germany and France will serve as a reminder that even if some time has been bought for the euro zone to put its house in order, it is heading firmly for recession with little prospect of a strong recovery thereafter. Germany’s ZEW sentiment index and a slew of British economic data is unlikely to look much prettier.

German Finance Minister Wolfgang Schaeuble questioned the need for a Spanish bailout if the country's borrowing costs continued to fall anyway. Join Discussion

Biggest analyst split on ECB rate decision since euro launch

Some say the European Central Bank will cut rates. Some say they won’t.

The odds that either prediction could turn out to be true on Thursday are more even than since Reuters first began polling on ECB rates in 1999.

Even during the highly volatile, uncertain time that followed the collapse of Lehman Brothers, Reuters polls of ECB watchers always resulted in a clear majority of economists leaning toward one particular rate cut size.

In the Reuters poll taken last week, 36 of 70 economists expected the ECB to leave the refi rate at 0.75 percent, while almost as many, 34, said it would cut it to 0.50 percent.

The obvious explanation for the split is that the main focus clearly is not on interest rates.

A central bank source told Reuters on Wednesday that there “would be no time to discuss interest rates.”

Some say the European Central Bank will cut rates. Some say they won't. Join Discussion

Fund managers also fall prey to economists’ euro zone bias

If Reuters polls onthe euro zone this year have proved anything, it’s that forecasts concerning the future of the currency union really boil down to national bias and not just plain economics.

Last week’s global polls of fund managers proved that’s just as true of investors as it is for analysts.

It’s a well-established trend: economists working for institutions based inside the euro zone are far more optimistic about its future than those from Britain or the United States.

While that might not sound surprising, it somewhat undermines the idea their analyses are based purely on economics, and less on national perspective.

Fund managers, who control trillions of dollars (and euros) in assets, are just as prone to this sort of bias.

Not long after European Central Bank President Mario Draghi gave a strong signal he would do whatever it takes to defend the euro, the poll of global funds revealed UK and U.S. investors reduced holdings of euro zone bonds, while those based in the euro zone raised them.

If Reuters polls about the euro zone this year have proved anything, it’s that forecasts concerning the currency union really boil down to national bias rather than plain economics. Join Discussion

Spanish yield curve flattens, along with Europe’s fortunes

Ten-year Spanish government bond yields hit their highest levels since the euro was created – above 7 percent – on growing doubts that the euro zone’s fourth largest economy will be able to avoid a full-blown sovereign bailout.

News that Spain’s heavily indebted eastern region of Valencia would ask Madrid for financial help reinforced concerns the country may eventually run out of funds. The rubber-stamping of a rescue package for Spain’s troubled banking sector did little to allay concerns.

Short-dated bonds came under particular pressure, flattening the Spanish yield curve further in a sign of mounting credit worries. Five-year bond yields hit a euro-era high of 6.928 percent, flirting with the widely dreaded 7 percent mark.

Charles Diebel, head of market strategy at Lloyds Bank says:

The more pressure you put on the front end … it is saying that the near-term risk of default is going up through the roof. It’s exactly the dynamic you saw in all of the other curves before they went into a bailout. You actually saw things like the Greek curve invert.

Asked when such an inversion — where short-term yields would actually surpass long-term ones — may take place for Spain, he said:

It always happens faster than you think. They haven’t got the summer, put it that way.

A flatter Spanish yield curve could be a hint that Europe's crisis is about to take a turn for the worse. Join Discussion

Surprise plunge in bond yield forecasts may spell more trouble ahead

By Rahul Karunakar

The spread between 2- and 10-year U.S. Treasury yields will shrink to 180 basis points in a year according to the latest Reuters bonds poll – the narrowest margin since August 2008, the month before Lehman Brothers collapsed.

Historically, that spread has been a key indication of what investors and traders are thinking about the economy’s prospects: the narrower it gets, certainly with short-term rates already at rock bottom, the darker the outlook.

It wasn’t looking particularly good in August 2008, and of course we all know what happened the following month: the start of an epic financial and economic crisis the world is still struggling to shake off.

A narrowing spread, driven by long-dated yields falling, might be welcomed by central banks who are aiming to bring them down to stimulate growth. But it’s also a dark sign for what people broadly feel is going to happen in the economy.

Said John Silvia, chief economist at Wells Fargo:

“I don’t think it is good news. It just tells you that the overall expectation for growth in the U.S. is weaker over time.”

Plunging bond yield forecasts may spell trouble for economy Join Discussion

Who expects euro bonds? Look outside the euro zone

It’s already been established that economists’ predictions about the euro zone’s future hinge largely on where their employer is based. Euro zone optimists tend to work for euro zone banks and research houses, and euro zone sceptics for companies based outside the currency union.

It somewhat undermined the idea their analyses are based purely on hard-headed economics, and less on national factors.

There was an echo of that in this week’s of economists and fixed income strategists, who were asked whether they expect euro zone leaders will agree to the issuance of a common euro zone bond, as backed by new French President Francois Hollande.

Only seven out of 18 analysts thought such a bond would come to fruition.

And of those seven? Six hailed from institutions based outside the euro zone, with a German private bank making for the remaining one.

There are several conclusions that can be drawn from this. Firstly, it could be that only economists from non-euro zone organisations think the region’s crisis will escalate enough for Germany to accede to the formation of a fully-fledged debt union.

That backs up the sort of bias we saw in last week’s poll.

It’s already been established that economists’ predictions about the euro zone’s future hinge largely on where their employer is based. Euro zone optimists tend to work for euro zone banks and research houses, and euro zone sceptics for companies based outside the currency union. Join Discussion

Breaking up is hard to do – even for stoic Germany

German Bund futures have just had their second straight week of losses. This has left many scratching their heads given the timing – right before Greek elections that could decide the country’s future in the euro and the next phase of the euro zone debt crisis. That sort of uncertainty would normally bolster bunds, which are seen as a safe-haven because of the country’s economic strength.

To explain the move, analysts pointed to profit-taking on recent hefty gains, and to a bout of long-dated supply from highly-rated Austria, the Netherlands and the European Financial Stability Fund this week. They also noted changes in Danish pension fund rules as an additional technical factor reducing demand for longer-dated German debt.

The losses, however, have also prompted some debate about whether contagion is spreading to Germany, the euro zone’s largest economy.

The thinking is that Germany will likely pay a high price for whatever the outcome of the euro zone debt crisis – be it further sovereign bailouts or issuance of common euro zone bonds. Euro bonds could drive German yields higher, but many market analysts still see them as the best and perhaps only way of drawing a line under the crisis.

A break-up of the single currency meanwhile would be extremely messy and costly – especially for Germany.

According to one trader in London:

(German Chancellor Angela Merkel’s) tone has changed a little bit, and I think that that’s Germany admitting that ‘hey we benefited from the euro too. We are one of the world’s most effective producer of economic goods and for five years now we have been maintaining a currency that is artificially weak versus what our economic fundamentals suggest.’

Realistically their currency should be appreciating much like the dollar has in these crisis periods. But instead during these crisis periods they are pegged to a currency that continues to depreciate. You are looking at a pretty significant boost to Germany’s economy.

Those are the arguments behind the fundamentals of what’s driving the Bund market and it’s really hard to say where their value is.

The market decided to run the numbers very recently and they came to this conclusion that Germany stands to really take it on the chin, I think that’s what we are looking at. If the euro zone breaks up, Germany stands to be a loser of that.

Germany remains the strongest economy in Europe, but it stands to lose a great deal from a potential break-up of the euro zone. Join Discussion

Euro zone survival is in the eye of the beholder

Despite all their years of experience and complex mathematical models, for economists the question of the euro zone’s survival really has them at the mercy of national bias… at least in terms of where their employer is based.

One of the key points from the latest Reuters poll was that a majority of economists from banks and research houses around the world – 37 out of 59 – expect the euro zone to survive in its current form for the next 12 months.

But behind that headline figure, the answers were skewed heavily by region.

Only 5 out of 24 economists from organisations based inside the euro zone thought it would fail to survive in its present 17-nation form over the next 12 months.

But nearly half (17 out of 35) of those employed by institutions based outside the euro zone – British, North American, Scandinavian or Swiss – expected to see at least one country leave the currency union over the next year.

“Will the euro zone survive in its current form for the next 12 months?” sounds like a scientific question. But clearly the answer depends at least partly on the locale of an economist’s employer, rather than economics.

Despite all their years of experience and complex mathematical models, for economists the question of the euro zone’s survival really has them at the mercy of national bias... at least in terms of where their employer is based. Join Discussion

Is Germany the next domino?

Throughout Europe’s financial crisis, German government bonds have been seen as a safe-haven for those seeking protection against the troubles of southern Europe. However, the confidence of financial markets in Germany’s finances may finally be starting to falter as the cost of a festering financial crisis rises – and the country is seen as ultimately holding the bag.

Demand at the latest government bond auction remained solid. However, the slide in German bunds continued into a second day and, worryingly, it was driven in part by worries about contagion after Spain’s poorly-received 100 billion euro bank bailout.

According to Capital Economics:

The last few days have brought clear signs that bunds are finally losing their safe-haven status.

The markets are starting to see bad news for the periphery as bad news for Germany too. If so, there would appear to be scope for this process to continue as the crisis deepens and the fork in the road to either fiscal union or break-up gets nearer.

Germany's bonds have so far been a safe-haven to the European crisis, but that could be starting to change. Join Discussion

Spanish bailout blues

100 billion used to be a big number. These days, it barely buys you a little time.

Euro zone finance ministers agreed on Saturday to lend Spain up to 100 billion euros ($125 billion) to shore up its ailing banks and Madrid said it would specify precisely how much it needs once independent audits report in just over a week. 

A bailout for Spain’s banks, struggling with bad debts since a property bubble burst, would make it the fourth country to seek assistance since the region’s debt crisis began, after Greece, Ireland and Portugal.

According to Nicholas Spiro at Spiro Sovereign Strategy:

(The) decision by the Spanish government to announce its intention to formally request external financial assistance is the most significant and alarming development in the two-year-old euro zone crisis.

One of the two southern European economies that matter most to the future of the euro zone, and the bloc’s fourth-largest, is no longer capable of managing its own financial affairs.

Market reaction is unlikely to be favourable given that the bailout places even more strain on Spain’s creditworthiness, sets a precedent that the euro zone’s other bailed-out countries (in particular Ireland) are likely to object to and risks putting pressure on Italy.

Speculation that a European policy response for Spain’s banking problems would soon come and hopes for more central bank stimulus eased pressure on Spanish yields this week, after they rose near 7 percent danger levels the week prior.

Any market reaction could be complicated by concerns about Italy, the euro zone´s third largest economy. Will a rescue for Spanish banks be enough to contain market pressure on riskier debt or will it fuel this by depleting the funds available to deal with Italy should contagion spread?

Spain became the fourth European nation to seek outside aid -- and the largest most important economy yet to come to that point. Join Discussion