European markets might have been able to shrug off the latest bad news from the Spanish economy, but it looks like bad political news is taking a heavy toll. The German DAX stock index closed down 2.5% today; the French CAC 40 fell 3%; Spain’s IBEX 35 dropped 3.77%; and the Italian FTSE MIB index plunged 4.5%.
The latest numbers, released today, show an additional 132,000 workers in Spain joining the ranks of the unemployed. That takes the total officially out of work to 4.98 million, a new record.
But what seems to have really rattled the markets today is political news from both Spain and Italy that threatens to produce weak governments that would not be able to (or might not be inclined to) continue the programs of economic reform and budget austerity that have stabilized the European debt markets.
In Spain the threat comes from a corruption scandal that has already led to opposition calls for the resignation of Prime Minister Mariano Rajoy. Beginning last Thursday newspapers in Spain have published stories, based on leaked documents, saying that Rajoy received 250,000 euros in income that was then hidden from tax authorities.
On Saturday Rajoy denied the allegations in a televised speech, but that certainly didn’t stop the damage. On Sunday opposition Socialist leaders called for the Prime Minister to resign. Opinion polls released that day show that Rajoy’s Popular Party, which soundly defeated the Socialists in November 2011, has fallen into what is essentially a dead heat with the Socialists. Neither party would win a majority of votes if an election were held today.
In Italy former Prime Minister Silvio Berlusconi continues to gain support in the run up to national elections on February 24-25. Read more
Financial markets rallied in 2012 and have continued that rally so far in 2013 despite worries over slow growth in the United States and the realities of no growth in Europe and Japan.
Why? Money from the world’ central banks and a belief in the power of those banks to backstop financial assets.
The traditional advice has been don’t fight the Fed. For 2012 that advice broadened into don’t fight the Fed and the European Central Bank. And in 2012 that was good advice as cheap money from the Fed and the European Central Bank and promises of even more cheap money if necessary more than made up for slow growth in the U.S. economy and no growth in European economies. Markets moved up on the central bank guarantee.
But I can see a major test of the belief in that guarantee shaping up around the middle of 2013. The big challenge to the markets this year, in my opinion, isn’t going to be the U.S. fiscal cliff or the battle over the debt ceiling or a continuing resolution to keep the U.S. government going.
We know from past experience that at some point, a market that believes it has a guarantee so over extends itself—the technology stock crash of 2000 and the housing crash of 2006-2007 are good examples—and that then the central bank guarantees turn out to be less powerful than everyone assumed and inadequate to head off the crisis. As I watch money flow back into Spanish and Italian bonds despite the lack of any solution to the underlying problems of the euro, I wonder if I’m watching a replay of that dynamic. I think not. I think the faith in the power of the central banks will weather this replay. But I can’t 100% rule out the possibility of the crisis getting serious enough to rattle that faith.
And with that in mind I think it’s worth taking a look at the shape of the likely replay of the euro debt crisis in an effort to see how much danger it represents to global financial markets.
I think I can make a strong case that we’re headed back to something like the same conditions that roiled markets back in the first half of 2012. I even think it’s fair to say that all the problems that were kicked down the road in 2012 rather than solved are about to return and bite us again in 2013.
What’s happened recently to convince me that we’re nearing crunch time in the EuroZone again? Read more
This morning’s stock market action is exactly what I meant when I said watch out for event risk.
European Central Bank President Mario Draghi confirms in a speech today that the ECB is committed to defending the euro and stocks roar ahead. As of 1:15 p.m. in New York the Standard & Poor’s 500 stock index is up 1.43%. The Germany DAX index closed up 2.75%. The French CAC 40 was up 4.07%. And the Spanish IBEX 35 was up 6.06%.
Draghi’s stirring words at a London conference? “To the extent that the size of these sovereign premia [high yields on Spanish and Italian bonds] hamper the functioning of the monetary policy transmission channel, they come within our mandate. Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. Believe me, it will be enough.”
So new? Read more
The plan to break the link between troubled banks and troubled sovereign debt that came out of the June 28-29 summit of European leaders looks badly frayed this morning.
The meeting of European finance ministers that began today and that really gets up to speed tomorrow has turned into a fight over what was actually agreed at the June summit. Some finance ministers and officials at the EuroZone finance ministers meeting today are saying that the June summit changed nothing and that any rescue money to European banks would still be the responsibility of national governments.
In their immediate post-summit statements it seemed like European leaders had agreed that the European rescue fund, the soon to go-into-business European Stability Mechanism, would be able to capitalize troubled banks directly rather than, as in the current system, having to send money to national governments that then send it on to banks. The way things are set up now any money from the rescue fund to a bank counts on the books of the individual national government. That puts the national government deeper in the hole, which hurts the bonds of that government that banks hold, which sends the price of those bonds down, which puts troubled banks further into trouble, which increases the size of any rescue they might need. The negative feedback loop is especially powerful since current European banking regulations encourage banks to buy the bonds of their own national governments by counting them as risk free capital.
But in the run up to today’s meeting of finance ministers senior officials at the Eurogroup, the organization of EuroZone finance ministers that is meeting today before tomorrow’s meeting of all European Union finance ministers, are saying that even if the bailout funds go straight to banks, the host national government would still have to take on the burden of the bailout money. Read more
Tomorrow’s summit needs to deliver something for Mario Monti or Italy could be headed out of the euro
The euro debt crisis calendar according to Italy provides yet more evidence that the summit of European leaders that begins tomorrow is make or break for the euro.
By this calendar the technocratic government of Mario Monti has only a month—effectively July–to pass economic reforms and to deliver some kind of short-term relief to the bond market and Italian voters and to head off early elections that could sweep anti-euro politicians into power in Rome.
Like most of Europe, Italy goes on vacation for August—nothing will get done during that month.
When Italian politicians return to business in September, you can expect the current jockeying for position to intensify. Read more