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Markets have been moving with much less regard to headlines than they were just a few months ago. But regardless of the fact that these events went under-reported, this week in Europe was monumental.And that’s not necessarily because anything important was accomplished. (In fact, we might argue the contrary.)
A brief recap
So in case you weren’t paying attention, let’s recap all the important events that happened this past week:
- On the credit ratings front, Standard & Poor’s made headlines when it first downgraded Greece to “selective default” and put the European Financial Stability Facility—the EFSF—on downgrade review. However, neither of these designations were truly surprising.
- The Irish government announced that it will hold a popular referendum on a new EU Treaty that would impose sanctions on countries that do not abide by certain financial discipline standards. That could stand in the way of the Treaty’s ratification, but that will all depend upon how the question is phrased; will this be a referendum on the terms of the treaty or will it be a referendum on the euro?
- Probably the most highly anticipated and highly scrutinized event of the week was the European Central Bank’s second and final (at least, for now) three-year long term refinancing operation (or LTRO). 800 banks applied for some €529.5 billion ($699 billion) in cheap central bank funding, slightly exceeding expectations of €470 billion.
- The International Swaps and Derivatives Association (ISDA) ruled that the insertion of collective action clauses (CACs) in private holdings of Greek bonds did not itself constitute a credit event, nor did the fact-pattern presented on an alleged subordination of private sector bond holdings to those of the ECB.
- All 17 eurozone leaders and 8 non-euro EU leaders agreed to a Treaty on fiscal discipline Friday toward the end of a two-day EU summit and agreed to push up implementation of the permanent bailout fund, the European Stability Mechanism (ESM).
Some worrisome signs
While none of these developments were particularly unexpected, none of them were reassuring either. Even take-up in the LTRO, which exceeded expectations, was not sufficient to truly reassure investors that the credit crunch in the banking system had been alleviated in the medium to long term.
We have argued before that the rose-coloured glasses with which investors have seen Europe are slowly defogging, and we can’t help but to reiterate this opinion amid the prospect of a great deal more negative headlines.
The Irish referendum is likely to yield a tight vote; the Irish have been among the most unhappy to accept austerity, given that their recession was primarily caused by the banking system.
The pain in SpainAt the same time, Spain has come under increasing fire, stealing the limelight from Italy in the bond markets today as the worst threat in Europe that has not yet been bailout out.
Compounding fears about Portugal’s continued ability to meet its debt and deficit targets are driving bets that it, too, will have to restructure its debts. That could take a massive toll on Spain’s banking system, which has heavy exposure to the neighbouring country.
Simultaneously, Spain’s leaders spar with members of the European Coalition and Germany over their statistics on public debt. German officials allege that Spain’s new Partido Popular administration is cooking the books and inflating its public debt statistics in order to convince the public that the recently ousted Socialist party did an even worse job than it appeared to.
This all happens as Spain’s unemployment hits new records every month. Right now, more than one in five Spanish workers are unemployed and a full half the youth population is out of work. The Spanish economy continues to deteriorate under the weight of new austerity measures.
What this means
The markets can continue to ignore Europe for a while, but now that the last LTRO is over and this last EU summit produced no unexpected new progress there are lots of reasons to believe that the situation is not going to improve anytime soon.
Europe still has the same old problems and infighting between EU leaders continues to complicate progress to fix them.
With investors waxing far more bullish than they were a few months ago and buying into the heady rally brought about by the LTRO, it’s hard not to look forward to see a sell-off (at least in Europe) coming in the near future. The time for disappointment is particularly ripe, too, since investor expectations have finally come in line with the surprisingly positive economic data coming out of the eurozone right now.
With an ECB decision forthcoming next week, the ESM still not funded sufficiently to induce more IMF participation, and the success of the Greek debt restructuring still very much up in the air, there will be plenty of opportunities in the next two weeks for negative headlines to turn the optimism around.
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