EUROPEAN MARKET INSIGHT
European stock markets pulled back last week as the EURO STOXX benchmark index lost 1.5 percent but the euro currency gained 1.5 percent to 1.2516.
Traders speculate that the euro rallied on technical momentum to close a divergence between European and U.S. interest rate swap spreads, as normally the stock market and the euro currency would rise or fall in unison.
Citigroup foreign exchange specialist Steven Englander commented in a note to clients, “When we look at our CitiFX Access positioning indicator we are struck by the swing in fortunes of euro. In less than a month the euro ... shifted from [a currency] that everyone loved to beat, to beginning to show significant longs.”
Greece Front and Center Again
“Our economy is bleeding,” said Greek Prime Minister Antonis Samaras of the New Democracy party in an interview with German daily Süddeutschen Zeitung last Thursday.
It is because of this reason that he has suggested Greece be given more time to implement budget cuts and other ways to raise revenue at a meeting with Eurogroup—the association of European Union finance ministers—chairman Jean-Claude Juncker last Wednesday. And Samaras is in no way exaggerating as Greek paper Thema reported that since the beginning of the year 1,250 businesses in Thessaloniki, the country’s second largest city, have shut down.
It was only in March that the country defaulted on 75 percent of its outstanding debt to the private sectors—banks and insurance companies as well as individual investors—whereas official holdings of Greek debt—mostly at the European Central Bank, the International Monetary Fund, as well as the European Financial Stability Mechanism—retained their full value. During the course of the debt restructuring, the above-named institutions agreed on a timeline for Greece to return to financial stability and solvency.
Patience Seems To Have Run Out
Samaras was lobbying for a two-year delay in the implementation of budget cuts during his visit to Berlin last Friday and Paris last Thursday.
German Chancellor Angela Merkel did not give any concessions and affirmed that she expects Greece to deliver on its promises, but also said that “[she wants] that Greece will stay part of the eurozone,” as Greek departure could lead to a “domino effect” of exits. French President François Hollande was even more tight-lipped and only spoke of a “difficult situation” for the country. Observers expected France to give Greece at least some verbal support.
Meanwhile, the German chancellor is struggling with more and more calls that a Greek exit could be manageable. A report by Financial Times Deutschland cites a spokesman of Finance Minister Wolfgang Schäuble saying that “there exists a task force that is predominantly studying the sovereign debt crisis,” and that the government is preparing for all eventualities. Sources inside the ministry said that colleagues are calculating as to how a domino effect can be avoided.
German Government Not Unified
While these steps can be considered prudent behavior, there are other German politicians that belong to Merkel’s faction, much to the chancellor’s dismay, that are openly calling for throwing Greece out of the eurozone.
The general secretary of the coalition party CSU Alexander Dobrindt said in an interview with German weekly Bild am Sonntag that he sees a Greek exit in 2013 and also openly criticized the European Central Bank’s head Mario Draghi for abusing the ECB for “Italian interests.” He added that he was vehemently against unconditionally helping “debt-addicts.”
While Dobrindt does not hold the most important position in the German government and could be viewed as a fringe player, his criticism of the ECB is important, as the market knows that Germany needs to be unified in backing special easing measures of the central bank.
German central bank President Jens Weidmann—who Merkel backs—issued similar, albeit less provocative warnings in an interview with German weekly Der Spiegel when talking about ECB bond purchases: “Such a policy is for me too reminiscent of public funding via printing. … In democracies it is parliaments that should decide on such an extensive pooling of risks, and not central banks.” These comments could constitute part of the reason why equity markets went down and the euro went up.
Next...Domino Effect a Real Threat
Domino Effect a Real Threat
Despite Merkel’s fear of a domino effect and her desire to keep Greece in the eurozone, analysts believe that both a Greek exit and a domino effect are very real possibilities.
A report by investment bank Citigroup said, “While the ECB’s decisions may help limit the economic and financial market spillovers of ‘Grexit,’ the likelihood of ‘Grexit’ itself is coming into even sharper focus, in our view. There appears to be a sizeable—and probably unbridgeable gap between the Greek government’s ability to quickly cut the fiscal deficit and implement major supply-side reforms and privatizations, and the measures that creditor nations would require to extend further funding.” The crucial deadline for this event will be late September or early October, when the next report on Greece’s progress will be released. If Greece will miss the set targets again, it will be hard for the creditor nations to justify keeping the country in the eurozone.
In the eventuality of a Greek exit, a domino effect cannot be ruled out according to a report by think tank VOX. “If one country (Greece) departs from the eurozone … the current slow bank run from the south will accelerate quickly and become a massive bank run from most banks in southern Europe, and the banking system would stop working,” according to a VOX report. There have been three historical examples of failed currency unions in Europe—the Habsburg Empire, the Soviet Union, and Yugoslavia—that all led to a dissolution once the first member defected.
The Week Ahead
While September will be jam-packed with crucial events, such as the assessment on Greek progress, a Dutch election and a ruling of the German constitutional court on further aid measures as well as an ECB meeting, the last week of August provides only a few highlights.
German Finance Minister Wolfgang Schäuble will meet French Finance Minister Pierre Moscovici Monday and German Chancellor Angela Merkel will meet Italian PM Mario Monti Wednesday. Usually those meetings provide markets with some indication where the future direction of fiscal and monetary support is heading.
The economic data points worth watching will be the IFO German business climate assessment survey Wednesday and euro-area unemployment Friday.
