If the fast and furious events from the past few days in a revolutionary Egypt bear a striking resemblance to what happened in the spring of 2011, it is because they are strikingly comparable. Only this time, following the ouster of yet another US-supported "leader" by the US-supported military, the country's CDS has normalized at a level that is roughly double where it was two years ago as the implicit backing of the US looks increasingly shaky, following what was yet another bungled foreign policy venture by the Obama administration. But for now, the people are celebrating, just as they did in 2011. One wonders what happens between now and the next coup, somewhere two years (or less) hence. For now focus merely on who controls the Suez - after all that is really all that matters for the US.
The other major story of yesterday, Portugal, continues to be in limbo, following a "constructive" meeting last night between Paulo Portas, leader of Portugal’s conservative CDS party, and Social Democrat Prime Minister Pedro Passos Coelho, Renascenca radio says on its website. The meeting lasted about two hours and the future of coalition government was on the table. Since nothing was resolved, the two coalition partners will meet again this morning. But the damage has already been done and as Bloomberg's David Powell, and many more, write this morning, at this point a second bailout of Portugal looks all but assured.
Investors seem to be losing confidence in the sustainability of the Iberian nation’s public finances. The spread between the 10-year sovereign yields of Portugal and those of Germany has risen by 157 basis points to 624 basis points since Monday. The nation has moved increasingly toward insolvency since it was pushed out of financial markets. The debt-to- GDP ratio was projected by the IMF, in its seventh review of the country under its bailout package, to reach 122.9 percent by the end of this year versus 108 percent at the end of 2011, the year during which Portugal lost market access. That report was published last month.
The fund’s economists forecast a peak of that ratio to materialize next year. They looked for a rise to 124.2 percent by the end of 2014 and a decline to 123.1 percent in 2015 and 120.5 percent in 2016.
The forecasts are dependent on the country meeting its budget deficit reduction targets. The IMF staff looked for the primary budget deficit, a measure that excludes the interest costs of government debt, to decline to 1.1 percent of GDP this year from 2 percent of GDP last year. They also forecast the deficit to be transformed into a surplus of 0.4 percent of GDP in 2014, 1.8 percent of GDP in 2015 and 2.4 percent of GDP in 2016.
Those numbers would have contributed to the total budget balance starting to be in positive territory as early as this year. That figure was forecast to be in surplus by 0.8 percent of GDP in 2013, in deficit by 1.4 percent of GDP in 2014, and in surplus by 1.2 percent of GDP in 2015 after including “residual” factors — which encompass asset changes — privatization receipts and payments on government debt. That surplus seems unlikely to materialize.
The secretary of state for the budget, Luis Morais Sarmento, announced on June 28 that the budget deficit widened to 7.1 percent of GDP in the 12 months through March. That compared with a deficit of 6.4 percent for the calendar year of 2012 and 4.5 percent in the 12 months through March 2012, according to the country’s statistics agency.
The finance minister quit after failing to meet the IMF targets. Vitor Gaspar wrote in his resignation letter on Monday: “The repetition of this slippage undermined my credibility as finance minister.” He added: “The risks and challenges of the near future are enourmous.”
One of the major challenges is the stabilization of the economy. Output has declined for 10 consecutive quarters. The most recent year-over-year measure of GDP growth stood at minus 4 percent. Total production is 8.6 percent below its pre-crisis peak. It is at the lowest level since 2000, indicating more than a “lost decade”.
The banking system also appears to be facing serious funding problems. The year-over-year rate of growth of deposits, excluding those of monetary financial institutions and central government, stood at minus 7 percent in May.
Portugal will probably be unable to access the ECB’s Outright Monetary Transactions program to facilitate its return to financial markets. Mario Draghi said at the monthly press conference in March: “You know that OMTs cannot be used to enhance a return to the market.”
He elaborated in April: “I have defined what we mean by the return to the markets by a country. It has to be able to issue across the whole maturity spectrum, in sizeable amounts to a variety of buyers, and we have also specified other features, which continue to apply.”
That suggests the Troika may be asked for more financial assistance. The current program is scheduled to be wrapped up by next spring with the 12th and last review to be published on May 15.
Look for the Portugal story to remain on the front burner, especially following news overnight that Spanish banks exposure to sovereign debt represents 52% of total European bank exposure, or some $73.4 billion, according to El Confidencial which cites the latest BIS data.
Also look for Portugal to be mentioned (one hopes) on at least several occasions by the fawning press corps at today's ECB press conference.
Speaking of which with the US closed, the ECB will be front and center of today's market moving events, where the key event would be Mario Draghi reverting once more to an overly dovish tone: he will hardly unleash a rate cut today, but may well provide conditional forward guidance which may be quite EUR negative.
Recapping the main overnight stories from Europe:
- Spanish Bonds Drop Third Day as Demand Falls at Five-Year Sale
- German Stance on Greek Debt Unrelated to German Vote: Minister
- Spain Banks Hold $73.4b of Portugal Debt, Confidencial Says
- Italy Govt May Speed Arrears Payments to Cos. in 2H, Ansa Says
- Meister Rejects Euro Bonds, Euro Bills, Redemption Fund
- Dutch June Harmonized CPI Rises 3.2% From Year Earlier
- ECB Policy Results Lack Legitimacy, Buch Tells Handelsblatt
- Spain Govt to Pay For Part of Power Deficit, Cinco Dias Says
- Portugal’s Portas Aims to Heal Rift With Coelho in Portuguese Coalition
- Draghi’s Secret Rate Roadmap Coveted as Yields Jump
SocGen summarizes the key events in Europe today:
Portugal's political crisis is the least of the ECB's worries as it meets over monetary policy today, though the symptoms of the turmoil, PGB yields - which returned over 8% yesterday for the first time since last November - will be high on the priority list as higher yields are a common theme shared by the broader periphery since the last meeting in June. The ECB has been out on a limb since last week arguing the case against higher yields, pledging a long period of monetary accommodation.
As we discussed in last week's Market Alert, bond markets outside the US have been subjected to the force of rising UST yields as the Fed targets a graceful exit from stimulus in the next calendar year, but the messy price action in other geographies and global asset classes is putting official institutions like the ECB and BoE on the spot. Though G10 currencies like the EUR and GBP have weakened vs the USD since the 19 June FOMC, the boost to external demand from a cheaper currency threatens to be eroded by the spiralling cost of borrowing for households and governments. Caught between a stronger US economy but high domestic unemployment and weak domestic demand plus a spreading wave of austerity fatigue, it is the ECB course sets out for how it will navigate accommodative policy waters that will dictate how EUR currency and rates markets trade over the summer. A rate cut today is out of the question we think, in the light of better economic data since the June meeting, but more explicit forward guidance is not ruled out. The decline in excess liquidity may also guide expectations for efforts to flatten the Eonia curve.
The events currently taking in place in Portugal put an end to the optimism which had returned to the country after it managed to raise EUR3bn on its own in May. It is a reminder of the risks in countries where support for the incumbent government is falling, in Portugal's case to about 25% for PM Coelho's PSD party. It also validates the caution exercised by the ratings agencies that have systematically played down the successful bond sale. Any future upgrade from below investment grade will depend on the credibility to pull off durable deficit reduction. Until that's the case, the instability of the investor base is a recipe for the jitters observed this week.
The BoE is not expected to announce any change in policy today, but a press statement would allow governor Carney to immediately make his mark. Less dramatic than the first meeting presided by Mario Draghi at the ECB, but if transparency and communication are high on the list of objectives, then an accompanying statement today would offer markets some initial clarity on where the MPC stands on Bank Rate and the APT following strong mortgage and PMI data in the last week.
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We conclude as always with Jim Reid's comprehensive summary of the plethora of events in the past 24 hours.
Given the US holiday, markets are likely to be thin today but there are some big news stories floating around at the moment. Starting with Egypt, the latest is that former President Mursi is being held under house arrest in the Presidential Republican Guards Club after being ousted by the military yesterday evening.
General al-Sisi, the defence minister, announced the suspension of the constitution and that the head of the Supreme Court would be sworn in as president. A technocratic government would be installed to prepare for presidential elections, he said. In terms of the impact on oil supply, the head of the Suez Canal Authority gave a statement yesterday to say that the Suez Canal is secure and navigation is normal. Brent and WTI crude both gained 1.7% yesterday (both are relatively flat overnight).
The other major story of the last 24 hours is Portugal where there are some tentative signs that the coalition may try to negotiate a compromise in order to hold the government together. Prime Minister Coelho and leader of the junior CDS coalition party, Portas, reportedly had a “constructive” meeting last night at the PM’s official residence in Lisbon. Portas, whose protest at the government’s austerity policies threw the coalition into turmoil, said he wants to ensure a “viable solution” to government. But at the same he wants a guarantee that his party will have influence on government policy (Bloomberg). Coelho and Portas will reportedly meet again this morning, after which Coelho will meet President Silva today at 5pm local time. While the focus remains on the potential for elections if the coalition collapses, it should be noted that the opposition Socialists had originally requested the 2011 bailout before it left government. The events in Portugal are a poignant reminder that markets remain at the mercy of authorities, of which the latter have yet to find the solution to weak growth. This is unlikely to be the last political problem in Europe over the next few years.
In terms of the market reaction yesterday, it was the shorter-end of the curve that bore the brunt of the selloff as the Portuguese yield curve flattened. Two year yields spiked 150bp to a 7.5 month high of 4.5% while 10yr yields added 75bp to a year-to-date high of 7.336%. However they spent most of the day rallying back after hitting 8% briefly near the open. The country’s PSI equity index lost 4.5% with banks (-9.3%) leading the declines. The troika are reportedly due in Lisbon to start their next review on July 15, but that visit might now be delayed according to Reuters.
The Portugal and Egypt-driven selloff in the European session dissipated somewhat during the shortened US trading session. The lows in equities
coincided with the lows in 10yr UST yields which touched 2.41% before b cking up to close basically unchanged at 2.50%. Some reasonably solid US employment data helped markets along, including the ADP report (188k vs 160k expected) jobless claims (343k vs 345k) and the employment component of the ISM (+4.6 points to 54.7). The S&P500 managed to record a gain (+0.08%) before markets shut early.
Briefly touching on overnight markets, the stronger finish to the US session yesterday is helping lead Asian equities higher this morning. Gains are being seen on the Hang Seng (+1.9%), ASX200 (+1%) and Shanghai Composite (+1%) . The KOSPI (+0.3%) is holding onto early gains after reports that North and South Korea officially restored border communications today, and that citizens of the South will be allowed to visit the Gaesong joint industrial zone in the North. In the latest on China’s banking sector, it was reported that there were a record 1,137 wealth investment plans sold by 70 banks in the last two weeks of June, which was nearly 50% higher than the similar period ended June 14th (Bloomberg).
Looking ahead to today, the near-unanimous consensus amongst economists (including DB’s) is for no change in rates at today’s ECB meeting. For the record, only one economist is calling for a 25bp cut in the refi rate and no forecasters are calling for a cut in the deposit rate to negative territory. DB’s Wall and Moec do note that renewed financial market tensions (even before the events in Portugal this week) highlight risks of a policy easing, rates or otherwise. As ever, Draghi’s post-meeting comments will be a focus. Wall and Moec expect Draghi to underline the ECB’s easing bias and commitment to maintaining an accommodative stance “as long as is needed”. Differentiating the policy stance from the Fed will be an objective.
Outside of the ECB/Draghi, with US markets shut today the spotlight will remain on continuing developments in Egypt and Portugal. The BoE will also be meeting today in what will be Carney’s first MPC.