While hard information is scarce, concerns about deposit flight from Greek banks have increased since the 6 May elections. To the extent that such flight arises from liquidity concerns, the ECB can contain it (or its impact) via its various monetary policy and ELA operations. But, as Goldman Sachs notes in its Focus today, the ECB cannot deal with concerns about bank solvency and/or deposit currency redenomination. That requires a pan-Euro area guarantee of the Euro value of bank deposits by the fiscal authorities. Politically, it will not be domestically popular in Germany (inter alia) to extend such guarantees, however much Germany may benefit from arresting the financial instability deposit runs may cause. And institutionally, in order to contain the threat of free-riding on the guarantee of others, entering into a pan-Euro area deposit guarantee would need to be associated with a deepening of the pan-Euro area system of financial supervision and regulation. This would involve substantial loss of sovereignty relative to the status quo and require significant institutional innovation. However, attractive in principle, even Goldman agrees with our skeptical perspective that it is unlikely that such a guarantee can be implemented credibly in short order. So, what would you do with your hard-earned deposits? Demand them or leave them at the bank on the basis that the EU leaders will do what they promise - this time is different.
With only new home sales (which we actually report as opposed to NAR goalseeked marketing materials) to hit the docket in the US, the only newsflow that matters again will be that coming out of Europe, which is holding an informal summit. As BofA reminds us, the summit was originally set up to discuss growth. Now, it is there for Grexit damage control. Today's discussions will focus on the use of existing tools for supporting short-term growth. Spain and Greece are likely to be on the agenda as well. On Greece, although discussions should focus on the pros and cons of a Greek exit, we believe there will be no communiqué other than to mention that Greece should stay in the euro area and implement the programme. On Spain, discussions will likely focus on the banking sector. The discussion will likely be around using the EFSF (or its successor ESM) directly to fund the banking sector, a step Germany opposed in the past. Overall, we do not expect many decisions from the summit. Rather, we expect a communiqué about what was officially discussed, and a date for a later rendezvous. In other words, "investors are likely to be let down by today's summit" (that was BofA's assessment). Also let down, were markets in the overnight session when the BOJ, contrary to some expectations, left its QE program unchanged. As usual keep an eye on headlines: record EUR interest means violent short covering squeezes if the algos sense a hint of optimism in any red flashing text (if only briefly, as the long-term outlook for the situation is quite hopeless).
Just when one thought it was safe to come out of hiding from under the school desk after the latest nuclear bomb drill (because Europe once again plans on recycling the Euro bond gambit - just like it did in 2011 - so all shall be well), here comes David Rosenberg carrying the launch codes, and setting off the mushroom cloud.
We have not been shy to point out the potential (and now proven) flaws in the Euro experiment (here, here, and here for example) over the past year or so but UBS reminds us that while most people remain fixated on the absence of a fiscal transfer union in so large a monetary union (to offset incidents of inappropriate monetary policy) as Eurobonds and Federalism come back to the fore; it is the second flaw - the absence of an integrated banking system (backed implicitly by a credible lender of last resort) - that should be getting front-page headlines. As Niall Ferguson noted at Zeitgeist this morning, "Structural reforms will work but will not work this week" and in the meantime, TARGET2 balances grow out of control and the longer the 'problem' remains, the worse it becomes leaving an implicit infinitely supported firewall as the only interim solution. While most who foresaw the Euro as implicitly leading to federalism were right, it seems the link to a German dominance (of ECB rulings and general fiscal and monetary decisions) has been the ultimate outcome. While an integrated banking system would do nothing to change the relative competitiveness or growth issues that plague Europe, the 'essential' internal capital flows would be sustained. Is this sort of integration a realistic prospect? The politics is not especially propitious.
The standard Keynesian narrative that "Households and countries are not spending because they can’t borrow the funds to do so, and the best way to revive growth, the argument goes, is to find ways to get the money flowing again." is not working. In fact, former IMF Director Raghuram Rajan points out, today’s economic troubles are not simply the result of inadequate demand but the result, equally, of a distorted supply side as technology and foreign competition means that "advanced economies were losing their ability to grow by making useful things." Detailing his view of the mistakes of the Keynesian dream, Rajan notes "The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.", and critically his conclusion that the industrial countries have a choice. They can act as if all is well except that their consumers are in a funk and so what John Maynard Keynes called “animal spirits” must be revived through stimulus measures. Or they can treat the crisis as a wake-up call and move to fix all that has been papered over in the last few decades and thus put themselves in a better position to take advantage of coming opportunities.
At the beginning of the week, European equities are seen modestly higher in the major indices with underperformance noted in the peripheral markets. Markets have sought some solace in the G8 summit over the weekend, with leaders agreeing that the optimal scenario would be Greece remaining within the European Monetary Union, and have furtively agreed that further measures may be necessary to return Europe to growth. The disagreements, however, continue to rollover as leaders fail to commit to a specific growth strategy. The tentative risk sentiment is reflected in the fixed income markets, with the German Bund remaining in negative territory for much of the session and 10yr government bond yield spread between the periphery and the German benchmark tighter on the session. Touted bids by domestic accounts helped support BTPs (Italian paper), especially in the short end of the curve, where the spread between the German equivalent is trading tighter by around 3bps. From Tokyo, comments from Fed’s Lockhart have drawn attention, who commented that with the downside risks emerging from the Eurozone, it would be unwise to take QE3 off the table.
So stepping aside from the biggest aggregator of private data for a few minutes, and focusing on what actually matters, here is Citigroup telling our European readers who have those fancy multi-colored bills in their wallets, that they are in deep trouble.
To summarize from Citi:
- There are many scenarios for a Greek exit; almost all of them are likely to be EUR negative for an extended period
- Some scenarios could be positive in equilibrium but the run-up to the new equilibrium could be nasty, brutal and long
- The positive scenarios for the euro involve aggressive reduction of tail risk; none of these seem likely
- It is unlikely that central banks busily substitute EUR for USD in their portfolios during periods of intense political uncertainty.
With a lack of European data, markets have remained focused on the macroeconomic issues throughout the morning. European equities have seen mixed trade this morning, starting off sharply lower following Moody’s downgrade of 16 Spanish banks late last night. Equities have been observed on a relatively upwards trend as market talk of asset reallocation into stocks from fixed-income has somewhat buoyed sentiment, however this remains unconfirmed. The news that Spanish banks are pressing regulators to reinstate a short-selling ban on domestic banking stocks has also helped keep negative sentiment towards Spanish financials at bay, with Bankia dramatically reversing recent trends and seen higher by around 25% at the midpoint of the session...The chief of the Australia and New Zealand Banking Group has said volatile conditions in global markets have caused the wholesale funding market for Australian banks to freeze, a further sign that the European turmoil is taking its toll on global markets.
'Don't Fight The Fed' is the mantra that is repeated day-in and day-out by so-called investment professionals around the world. In this world of extreme monetary policy and a market hungry for its next fix of fiat liquidity, this may well be the case - though even then, the actions are having less and less effect on both the real economy and market each time they roll the dice. However, it does seem that the ECB's approach to encumbrance as opposed to just unlimited printing is absolutely what should be faded. As we noted earlier, equity and credit markets have turned negative for 2012 now, but without doubt the cleanest and best performing trade of the first half of 2012 (and likely the git that will keep on giving) is the LTRO Stigma. With the spread between banks that took LTRO loans and those that did not now more than triple its early-February tights (and very close to record wides - with little or no excess collateral to revive LTRO3 hopes for those that need it), our recommendation back in early February to initiate this decompression strategy, calling out Draghi as a liar for disingenuous comments on the implicit encumbrance of the ECB's actions, has performed admirably (and we expect it to continue - though taking some profits up here and leaving a runner may well be warranted).
Because it is one thing to predict the inevitable when one doesn't have a PhD in Economics, it is something totally different when it comes from the likes of Goldman Sachs (Huw Pill and Themistokis Fiotakis to be precise). In this case, that something is what happens at T+1, T being the inevitable (there's that word again) point where payments from the ECB to sustain the zombified Greek patient, all of which go to ECB funded entities anyway, stop. The biggest concern is that, as we suggested first thing this morning, the ECB is now engaged in a fatal game of chicken, whereby it is forcing Greeks to vote "Pro Bailout" (something that just dawned on the FT), in exchange for continued funding, because unlike last year when the threat of a referendum resulted in the termination of G-Pap, now there is no leader who can be sacrificed, and Europe has no real leverage over the people who have lost so much already, aside from threatening a full out bank system collapse. However, this could very well backfire as more and more Greeks pull their money out, not wanting to find out who blinks first as it would be their money that could be locked up in perpetuity, in essence making the ECB threat into a self-fulfilling prophecy. And as Goldman says, "If confidence is lost and a run on banks occurs, the implications are hard to assess." Well, as ZH warned yesterday, this is already starting. Again from the FT: "Athens-based bankers said withdrawals exceeded €1.2bn on Monday and Tuesday – 0.75 per cent of deposits – as President Karolos Papoulias failed in two final meetings with conservative, socialist and leftwing leaders to form a national unity government." Or double what was suggested yesterday...
- SEVERAL ON FOMC SAID EASING MAY BE NEEDED IF RECOVERY FALTERS
- MOST' FOMC PARTICIPANTS SAW GRADUAL DECLINE IN JOBLESS RATE
- MOST FOMC PARTICIPANTS SAW INFLATION SUBSEQUENTLY AT-BELOW 2%
- MOST FOMC MEMBERS SAW UNEMPLOYMENT ABOVE TARGET IN LATE 2014
- SOME PARTICIPANTS SAW RISKS INFLATION PRESSURES COULD BUILD
Actually, nothing new in the minutes which are largely a rehash of the official statement already released.
Just as we predicted moments ago, and as Dutch Dagblad warned overnight:
- ECB STOPS MONETARY POLICY OPERATIONS TO SOME GREEK BANKS AS RECAPITALISATION NOT IN PLACE -CENBANK SOURCES
The beginning of the end? Or just more political posturing? In the meantime, EURUSD tumbles.