Photo: Mary Margret on Flickr
The markets face a landmark week ahead, and much of that excitement comes from Europe.A meeting of the European Central Bank on Thursday, we’ll have elections in Greece and France that could decide whether there will be ongoing support for the German-led way the crisis is being handled. Not to mention the nagging threat that Moody’s will begin a string of bank downgrades, beginning with Italian banks sometime early this month.
The crisis appears to have entered into a new phase recently, where overwhelming amounts of liquidity have diminished the immediate risks of Spain, Italy, and Portugal going illiquid.
Even so, the success of EU leaders to promote growth and impose sustainable reforms could determine whether or not the eurozone as we know it lives or dies.
Moody's slashed Spain's credit rating from A to BBB+ this past week, meaning sovereign bonds are now on the low-end of what it would consider investment grade securities.
Citi analysts predict that Italy, Portugal, and Ireland could also see another ratings downgrade within the year, and they predict more sweeping downgrades of countries like the U.S. and Japan over the next two to three years.
Downgrades by two of three ratings agencies would result in widespread margin calls, which would increase the collateral financial institutions have to hold against borrowing. This increase in stress on the financial sector would frighten investors, and add to concerns about the increasing scarcity of safe assets.
Moody's ratings agency has put the ratings of most euro zone banks on downgrade review, and it announced earlier this month that it will start releasing final decisions on these banks come early May.
The first under fire? Italian banks, shares of which have been tanking in value recently.
Here's the full Moody's timetable:
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The ECB is just beginning to feel the backlash from two three-year long-term refinancing operations that gave cheap money to banks. Initially, the new wealth of cash increased demand for sovereign bonds, drastically lowering borrowing costs for countries like Italy, Spain, and Portugal.
But investors have become worried that banks in Spain and Italy particularly now hold high quantities of domestic sovereign debt, more closely linking the viability of countries and their financial sectors. Analysts are only beginning to explore the effects of this relationship, but initial commentary about the relationship between the two appears to be worrisome if the financial sector threatens to drag down the sovereign or vice versa.
More worrisome still are recent announcements by two of Spain's biggest banks that they will not increase their purchases of domestic sovereign debt out of concerns about too much exposure to their own government.
German Bundesbank President Jens Weidmann has spoken out against the ECB's expansionary monetary policy, arguing against more accommodation on the grounds that inflation would be bad for Europe. This is worrisome considering ECB President Mario Draghi's comments during his last press conference detailing the bank's concerns about inflation.
In general, the bank does not appear to be leaning towards another LTRO anytime soon--although some analysts predict they will ultimately come to the eurozone's rescue and fire up the presses--however, it is clear that the Bundesbank will fight any more attempts to ease Europe's way out of problems.
We'll hear the latest on the ECB's outlook and policy action on Thursday, May 3.
The percentage of banks' non-performing loans hit a record level since 1994, at 8.16 per cent in February. Austerity measures adopted by the Spanish government to reign in deficits is only expected to make this number worse, as fewer individuals and businesses are able to pay off their loans.
More and more economists are beginning to predict that Spain's banks will need a bailout in the near future, either from Spain or from the EU/ECB/IMF troika. Further, Spain has become dependent upon these banks to foot the bill for their debt issuances, meaning that the government is also coming under fire in the markets.
While five bank mergers in the next few months are expected to cleanse some bank balance sheets, most analysts are sceptical that this will do enough to restore confidence in Spain's financial sector.
Spain's autonomous communities have been notoriously profligate spenders, and the central government is struggling to bring their budgets and policies in line. This may be difficult to do, however, considering that communities like Catalonia have publicly flouted budget rules. In Andalusia, local elections did not return a majority for the ruling Partido Popular party, calling the success of austerity measures backed by the central government into question.
While EU leaders finally agreed to add €500 billion in funding from the European Stability Mechanism to some €200 billion in promised funding for Greece, Portugal, and Ireland, most analysts agree the size of funding available is still far too small for comfort.
The IMF earned more contributions during joint IMF-World Bank meetings in Washington, D.C., last week. However, the $400 billion it is likely to add to its capacity is far less than it had previously desired.
The collapse of the Dutch coalition and support for right-wing candidate Marine Le Pen in the French elections this weekend have both shed light on a significant contingent of euro-sceptics fighting back against efforts to bail out the rest of Europe. This calls the success of EU crisis measures into question moving forward.
Greece is scheduled to hold a new round of parliamentary elections on May 6, after six months of a technocrat government that pushed through unpopular austerity measures and economic reforms. The two main parties--PASOK and New Democracy--which formed the majority of this Administration, are currently positioned to win a narrow combined majority, as 40.1 per cent of the votes would win them 158 of the country's 300 parliamentary seats.
However, these parties have become increasingly unpopular as Greece struggles to survive its fifth year of recession. Violent protests have added to the angst, calling into question support from EU-led economic reforms.
Irish politicians decided that a referendum was necessary to approve the latest EU Treaty which would impose automatic sanctions on countries that fail to meet debt and deficit goals. While the Irish public is expected to ultimately approve the plan, earlier referendum failures have left investors concerned about the immediate success of this one.
According to Citi analysts, 'The Yes vote is now at 30% (28% last October), while the No vote has fallen to 23% (compared to 47% last October). However, 39% are now Undecided (25% last October), while 8% say they will not vote. If Undecided voters and those who say they will not vote are excluded, the Yes vote is ahead by 58% to 42%. This poll shows that, with six weeks to go, the outcome is in the hands of the Undecided.'
58 per cent of Irish voters also believe that Ireland will need another bailout by the conclusion of the current aid program on 2014, and 66 per cent have a favourable attitude towards EU membership.
Despite mounting angst about Italy and Spain, Portugal remains the country most at risk of a sovereign default. The country continues to pay through the nose to borrow in the markets, with 10-year government bonds trading at yields above 11 per cent. That's an improvement from just a few months ago, when they soared past 17 per cent, indicating that some of the drama is likely overblown.
A failed government in the Netherlands, support for Socialist presidential candidate Francois Hollande in France, and mounting pressures on Spanish banks have led analysts to comment on the beginnings of a shift away from German-backed austerity.
While EU leaders still appear focused on imposing harsh economic reforms in peripheral Europe, more and more are beginning to question the wisdom of continuing with efforts to cut spending dramatically without mitigating the damage like eurobonds or a stronger role for the ECB.
Despite optimism that this is occurring, a true change in ideology is likely still far off. Northern Europeans remain stalwart against policies which would result in steeper inflation or more bailout money for their troubled Southern peers.
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