We start today's story of the day by pointing out that Deutsche Bank - easily Europe's most critical financial institution - reported results that were far worse than expected, following a decline in equity and debt trading revenues of 23% and 8%, but primarily due to Europe simply "not being fixed yet" despite what its various politicians tell us. And if DB is still impaired, then something else will have to give. Next, we go to none other than Deutsche Bank strategist Jim Reid, who in his daily Morning Reid piece, reminds the world that with austerity still the primary driver in a double dipping Europe (luckily... at least for now, because no matter how many economists repeat the dogmatic mantra, more debt will never fix an excess debt problem, and in reality austerity is the wrong word - the right one is deleveraging) to wit: "an unconditional ECB is probably what Europe needs now given the austerity drive." However, as German taxpayers who will never fall for unconditional money printing by the ECB (at least someone remembers the Weimar case), the ECB will likely have to keep coming up with creative solutions. Which bring us to the story du jour brought by Suddeutsche Zeitung, according to which the ECB and countries that use the euro are working on an initiative to allow cash-strapped banks direct access to funding from the European Stability Mechanism. As a reminder, both Germany and the ECB have been against this kind of direct uncollateralized, unsterilized injections, so this move is likely a precursor to even more pervasive easing by the European central bank, with the only question being how many headlines of denials by Schauble will hit the tape before this plan is approved. And if all eyes are again back on the ECB, does it mean that the recent distraction face by the IMF can now be forgotten, and more importantly, if the ECB is once again prepping to reliquify, just how bad are things again in Europe? And what happens if this time around the plan to fix a solvency problem with more electronic 1s and 0s does not work?
Here is Deutsche Bank's Jim Reid redirecting attention back to where it was all throughout the summer and fall of 2011, until the new Goldman-based head of the ECB relented days after his appointment:
Of major Western developed countries, the UK now joins Greece, Italy, Portugal, Ireland, Belgium, Denmark, Holland, Czech Republic, and Slovenia as being in recession. By the time the data comes out next week its likely to be followed by Spain and remember German GDP was negative in Q4 and is expected to be flat in Q1 so its not impossible that they will also follow. Most other countries in the West are currently not far off recession so more may join the pack this year. Perhaps the furthest away from recession is the US and it is no co-incidence that of the countries in our sample they have the combination of having a high deficit and one that is reducing by far less than virtually all their peers. Those in recession either have a much lower annual deficit or have seen their deficit shrink more aggressively.
So if you had an argument against our shorter business cycle theory for the US then you might state that they don't yet have a fiscal straight jacket and therefore still have flexibility to avoid a recession. Back in 2010 we thought it was unlikely that they could survive through to 2013 without a recession but clearly much depends on fiscal and monetary policy going forward. The election in November could be key here. Has the US been proved right and everywhere else proved wrong? Or is it just that the US has more international financial credibility that allows it to run higher deficits than other countries? If others copied the US then maybe a debt crisis would have occurred. Which to be fair is what has happened in many areas.
However if you wanted to be optimistic for those in recession, could we eventually look back on this week as being a pivotal one where the authorities finally realised that austerity without unconditional monetary support at this point in the structural cycle is detrimental to growth? One of the things we mentioned on our conference call earlier this week (replay details at the end) was that amongst the current renewed evidence of renewed economic weakness and political turmoil (in Holland and France) then maybe Europe would finally start to appreciate that they have the wrong policies in place to keep the crisis at bay. So its possible that we may get a different political agenda in Europe emerging. Indeed Merkel caught the mood yesterday as she suggested that austerity alone will not resolve the crisis and added that “we need growth in the form of sustainable initiatives, not simply economic stimulus programs that just increase government debt”. However its all very well saying that you want growth but its another thing achieving it. We're not sure what can be done in a deleveraging world to actually get decent growth outside of increasing Government spending which isn't going to happen for obvious Sovereign crisis avoidance reasons. Maybe a slower pace of cuts helps but it doesn't mean growth will be aggressively high. We can't help thinking a much weaker Euro would be the best thing for growth on the continent. However that probably only happens with a much more aggressive, unconditional and consistently intervening ECB. If we had that maybe Europe could get higher growth.
So maybe we may be starting to see the origins of a different political emphasis emerging towards growth but we're scratching our heads as to how you actually get that. If it were that easy wouldn't every government always have a bias to promote it anyway??
As discussed the US stands apart for the time being and yesterday FOMC meeting showed again a slightly more upbeat economic assessment from the Fed. The Committee noted signs of improvement in the housing market and the decline in unemployment rate although inflation has picked up somewhat. The first rate hike forecast date was brought forward a bit with only four members projecting that it would come after 2014 (previously 6). What got the market excited however was another dovish performance from the Chairman. Bernanke said that “we remain entirely prepared to take additional balance sheet actions if necessary”. So further easing is certainly possible if data flow starts to turn south. In the past our economists have suggested that the Fed is from Venus and the ECB from Mars. While this gap between the planets has narrowed in the last 6 months we still think it is a fairly good reflection of the DNA of the respective institutions. As we mentioned above an unconditional ECB is probably what Europe needs now given the austerity drive.
So what happens next? This (via BBG):
The European Central Bank and countries that use the euro are working on an initiative to allow cash-strapped banks direct access to funding from the European Stability Mechanism, Sueddeutsche Zeitung reported.
The working group will examine how banks can directly access the funding within the next two weeks, the newspaper said. The move comes amid growing concern that Spanish banks are increasingly unable to lend to companies and that the crisis may spread to other euro countries, SZ reported.
And google translated from the original:
Germany rejects a direct lending to European banks of the ESM categorically. Finance Minister Wolfgang Schäuble (CDU), had declared at the weekend that he would not discuss it. The contracts would see such an option not available, and while it will remain so. Bundesbank President Jens Weidmann said the SZ, while the supervision was higher than the banks in the nation-states, this was crucial to take the responsibility if some banks need additional capital. Moreover, should continue to apply the principle that ESM loans only to the fulfillment of strict macroeconomic conditions and a "self-help" give.
"Liability and control shall be in any allocation of aid credits remain in balance," said Weidmann. The Netherlands, Austria and Finland reject the direct allocation of funds from ESM to banks. From the environment of the bailout fund was rumored that such plans were difficult to enforce.
Strapped banks are likely to continue to negotiate directly with the aid of ESM, the countries of the Euro-club rules would give up their previous part. These stipulate that only governments can apply for assistance, regardless of what they use the loans. The same goes for Bank assistance. There is also money from the ESM only applicable if the government comes up with an austerity and reform program in return. This was a crucial precondition for the approval of the German ESM.
In other words, everyone is once again protesting on the surface, for purely political and populist reasons, not to mention not attracting the attention of the German media once again, as the country just happens to be the biggest source of cash to the ESM: add that to the recently exponentially rising TARGET2 counterfunding by the BUBA and once can see why voters would be furious. And yet, underneath the surface more preparations are being made to debauch the EUR. The irony of course is that the EURUSD is actually up on the news as it removes some of the near-term threats to insolvent Spanish banks. Obviously the plan does nothing for the longer-term viability of Europe's insolvent financial system. But at least the can is kicked into the future, and by then it will be some other minister's problem.
Which is what this farce is all about.