- Little change was expected from the October FOMC rate-setting meeting. It was only a month and a half ago that FOMC members updated their economic projections. Thus there was nothing in the FOMC press release to change our view of the bond market. Moreover, our base case scenario for the economy has changed little. We continue to see weak growth going into 2013.
- The prospects for the Canadian economy obviously remain heavily contingent on how the U.S. handles its fiscal situation. If our forecast is on the mark, a 1% overnight rate may end up being well-justified in 2013 and long rates could weaken in Q1. In other words, our interest-rate forecast is unchanged from last month.
No fast track for European banking union
The June eurozone summit ended with a statement that “it is imperative to break the vicious circle between banks and sovereigns.” To this end the statement proposed that the ESM be able to recapitalize banks directly once a single supervisory mechanism (SSM) was established. Although many, including French finance minister Pierre Moscovici, may have hoped that the financial assistance to Spain’s banks could be delivered in this way, German chancellor Angela Merkel said no: “There will not be any backdated direct recapitalization. If recapitalization is possible, it will only be possible for the future.”
Although that felt like a cold shower to some, a wait for the single supervisor to be up and running might have delayed recapitalization. The legal framework establishing the SSM is likely to be implemented gradually over 2013, with effective supervision of all banks currently targeted for January 2014.
Establishment of the SSM will lay one cornerstone of a banking union. Yet at least two more are needed to properly strengthen the eurozone banking system: an autonomous resolution authority and a bank deposit insurance system covering all institutions under the SSM.
In light of Ms. Merkel’s stance, it appears that it is the July Memorandum of Understanding that will dictate how Spain’s banks will be recapitalized. A Fund for Orderly Bank Restructuring (“FROB,” from the Spanish name), acting as agent for the Spanish government, will receive ESM funds and inject the capital in specific banks. With FROB bonds explicitly, unconditionally and irrevocably guaranteed by the Kingdom of Spain, breaking the vicious circle between banks and sovereigns, however imperative, will have to wait.
The capital shortfall of Spain’s banks was estimated at €62 billion by an independent audit, while the Bank of Spain and its economy ministry are looking for an amount closer to €53.7 billion (roughly 5% of GDP). Although significant, this is well below the €100 billion suggested earlier this summer by many analysts.
In the meantime, legislation to set up a bad bank in Spain should be passed by November 19. Created to take over impaired assets, the Sociedad de Gestión de Activos Procedentes de la Reestructuración Bancaria (SAREB) should be operational in December. Its establishment was a condition set by the European Union for approval of aid to Spanish banks.
The government plans to limit its own stake and attract private investors to take up at least 55% of its capital. The assets to be transferred are expected to be priced in the seven days following November 19, on the basis of an evaluation by the auditing firm Oliver Wyman.
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