I am occasionally blessed with a not-so-busy weekend; one which allows me to take a bit more time to actually digest the week’s news, rather than just skim, scan, and absorb the main points. When I do, I tend to come away with a more complete picture, as I give myself time to see the interconnectedness of seemingly unrelated story lines. Below are five headlines from the past weekend that, when taken as a whole, offer a fuller picture of what is happening (and what likely will happen) in Europe in the coming months. All headlines appeared in FT Weekend, March 3-4, 2012.
Eurozone Leaders Point to Recovery. It looks as though the panic has abated. The German DAX has risen 40 percent off this summer’s low. The yield on 10-year Italian bonds has dropped from the 7 percent “point of no return” to 4.92 percent as of Friday. European leaders, specifically French President Nicolas Sarkozy, are positively upbeat about the worst of the crisis being over. This was all on page one. If only I had stopped reading there.
Banks Park Record EUR 777 billion in cash with ECB overnight. The results of last week’s long-term refinancing operation (LTRO) were simply staggering. 800 banks borrowed EUR 530 billion in 3-year notes at one percent from the ECB, only to deposit more than half of it at the central bank, where it will earn the 0.25 percent overnight rate. If my thinking is correct, the banks are putting on one giant butterfly – borrow 3-year from the ECB, and buy ECB overnights and ten-year sovereign debt. I see the rationale – it has the look and feel of a hedged position, put on at quite a credit premium. What is clear is that banks have no intention of parking the stimulus with fellow banks, whose balance sheets they do not trust, nor into the “real economy,” which is still shrinking.
Spain plans to breach EU goals. Remember the EU’s statutory deficit limit of three percent of GDP? Last year Spain’s was 8.5 percent. They agreed earlier to a 4.4 percent target for 2012, but have acknowledged that, best case scenario, it will be 5.8. Next year, when the economy “grows two percent” they say they can hit the three percent target. Spain, like the rest of the European periphery, is shrinking in the face of austerity and a weakened economy. So, naturally, the eurozone leaders say a recovery is just on the horizon. I will not be holding my breath, waiting for a return of three percent deficits.
By the way, Nicolas Sarkozy is slipping in the polls, just ahead of round one of the presidential election April 22. “Eurozone leaders point to recovery,” says the headline.
Dublin begins difficult task of persuasion. There is a referendum scheduled in Ireland on its future status as a member of the EU. Ireland, of course, came early to the post-bubble austerity party. Now that the punch bowl has emptied, the country is questioning the wisdom of staying with the treaty. The way they view it, Ireland sacrificed independence for economic security, and is now faced with having neither.
Investors crave new shot of stimulus. In the U.S., a lack of willingness on the part of Federal Reserve Chairman Ben Bernanke to initiate another round of quantitative easing has left a bit of a chill in the market.
When viewed together, the relationship of these story lines is clear. Since U.S recession predated Europe’s woes by a few years, it is further along the timeline. At this point in the U.S. the market is saying that stimulus is not really a “one-off event” – it must continue, lest the tenuous recovery falter. The current ECB is really the same story, only a couple rounds behind in terms of stimulus. But, as we see in the U.S. case, the economy has a steady pulse, but only while receiving periodic shock treatments.
The biggest difference between the U.S. and Europe is that U.S. states may not leave the union and begin printing their own currency. If that were an option, my home state of Illinois would have done so long ago. Europe’s declaration that the worst is behind them is akin to Bernanke’s statement a few years ago that the subprime meltdown was “contained” and thus no threat to the real economy.
Ireland was the first “austerity experiment,” so naturally it is closer to the end game than other nations, and its impending referendum may set the tone for the future of the eurozone. Those who have the greatest stake in promoting confidence – bondholders and politicians – are eager to see a recovery in the works. In the end, though, it appears to be a gaming of the numbers to buy time and boost confidence. Lower long yields reflect demand by banks riding the curve, using the ECB as a backstop. The real economy is still experiencing a painful deleveraging.
News of the death of the eurozone crisis is greatly exaggerated.