Back on the Slippery Slope

After reaching its highest level since mid-December, euro-bulls beat a hasty retreat during the London trading session yesterday. There were numerous issues to worry about, including the CDU’s decision to scupper Angela Merkel’s idea that the EFSF and ESM could run in parallel, the German proposal to appoint an EU budget commissioner to veto tax and spending decisions in Greece and fresh concerns over the rapidly deteriorating state of affairs on the Iberian Peninsula. Yields on Portuguese sovereign bonds soared yesterday, with the 10yr reaching an extraordinary 17%; the market seems to be expecting (at the very least) a massive restructuring within the next few months. Italian yields did not escape, the 10yr yield up 25bp at one stage. European equities likewise were dumped, with the banks coming in for especially heavy treatment. Both the dollar and the yen were the main forex beneficiaries of this turn in risk appetite

Commentary

Germany applies the blowtorch to Greece. Having tried tough love on Greece for over a year now, clearly Germany has decided that it will need to apply the blowtorch instead. The weekend FT reported that Germany is demanding that Greece cedes control over its fiscal affairs to a European ‘budget commissioner’ who will have veto powers over both tax and spending decisions. Under this proposal, the commissioner would be able to thwart any fiscal initiatives that were not consistent with targets established by international lenders. Frustrated by a litany of broken promises on reform and fiscal consolidation, Germany is demanding that Greece agrees to this initiative or else new aid will not be forthcoming. German Finance Minister Schäuble warned on the weekend that, without implementation of agreed plans by Greece “there is no amount of money that can solve the problem”. Schäuble is, of course, absolutely correct. Greece’s abject failure to deliver on its commitments is causing enormous anger in northern Europe while making the situation in its economy considerably worse. Although this idea of sending in a budget commissioner has merit, Greece understandably, regards it as a loss of national sovereignty. As such, it will generate huge political opposition and moreover will be very difficult to implement. Chancellor Merkel discussed the proposal with Greek Prime Minister Papademos in Brussels yesterday. Doubtless it was an animated conversation on both sides.  

CDU scuppers EFSF-ESM merger plan. Angela Merkel’s hope that the firewall for Europe could be buttressed by allowing unused funds from the EFSF to be placed into the ESM have been blocked by her own party. According to a Bild am Sonntag story, her party has opposed the measure because Germany would have been liable for an additional EUR 211bln over and above what had already been approved. No doubt this was part of the explanation for the euro’s softness yesterday.

Sarkozy the reformer. Behind in the polls and desperate to invigorate his faltering election campaign, French President Sarkozy has belatedly discovered a reformist zeal. In an attempt to reduce the crippling labour-related costs to business, Sarkozy has announced a reduction of EUR 13bln by lowering the social charges levied on employers. This in turn is to be funded through an increase in the sales tax from 19.6% to 21.2% and an additional ’Tobin’ tax on financial transactions. Also, Sarkozy wants to permit companies to negotiate more flexible working hours with local unions, in effect diluting the statutory 35-hour working week. Although his conversion to reform at five minutes to midnight might give the appearance of the last act of a drowning man, he is to be commended for what is still a brave move. Unfortunately, the French population still does not appear to appreciate the straightened predicament it is in. France still fails to recognise that its social model is financial suicide when times are tough.

Rajoy’s tough fiscal choices. Faced with horrendous unemployment and an economy back in recession, Prime Minister Rajoy surely recognises the implausibility of achieving the 4.4% of GDP fiscal deficit target agreed with European leaders by the previous administration. After allowing for the significant shortfalls at the regional level, Spain’s deficit last year was above target at 8%. Recently, some ministers have been hinting that Rajoy may soon ask the EU for some fiscal forbearance for this year. Earlier today, Moody’s remarked that the achievement of Spain’s fiscal targets was complicated by the worsening economic situation, a development that was ‘credit negative’ for both Spain as a sovereign and her banks. In an endeavour to reassure Europe of his fiscal credentials, Rajoy has decided to implement some additional measures, including the temporary removal of a subsidy on new power plants using renewable energy. His cabinet has also agreed on a budget-stability law which in turn will become a constitutional amendment designed to ensure that all state administrations produce budgets that are structurally in balance by 2020. Rajoy has more tough fiscal choices to make. By some estimates he needs to make EUR 40bln of saving to hit the 4.4% target. Thus far, only EUR 15bln has been announced. Unless the EU cuts him some slack, he has a long way to go.

Aussie suffers a bout of vertigo. Having almost reached 1.07 in recent days, the Aussie suffered a bout of vertigo yesterday, down more than 1% at one stage. After such a sustained climb over recent weeks perhaps it was due for some consolidation. Perpetuating the decline were traders hunting for sell stops, and some profit-taking. In addition, the failure of China to lower reserve requirements after last week’s holiday hiatus did not help the mood. Fitch also announced that the long-term debt ratings of the four major Australian banks would be placed on negative watch. Continued nervousness in Europe ahead of yesterday’s summit also contributed to the Aussie’s demise. It has been a stellar run for the AUD – just two months back it was nearly 10% lower so the recovery has been impressive. 

 
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