14/12/15: U.S. Rates Impact on Euro: Expresso, December 12

My comments on potential impact on Euro and Euro area economy from the Fed rate hike for Portuguese Expresso (December, 12 page 03):

3/12/15: Of Debt, Central Banks and History Repeats

Couple of facts via Goldman Sachs' recent research note:

1. Since the start of 2008, U.S. corporate debt has doubled and the interest burden rose 40 percent. Even as a share of EBITDA, debt servicing costs are up 30 percent, so U.S. corporations’ ability to service debt has declined despite the average interest rate paid by the U.S. corporate currently stands at around 4 percent, as opposed to 6 percent in 2008.
2. Much of this debt mountain has gone not to productive activities, but into shares buybacks and M&As. Per Goldman’s note: “…the changing nature of corporate balance sheets does raise the question, again, about the lack of organic growth and reinvestment post the crisis.”

And the net conclusion? “…the spectre of rising rates, potential global disinflation, declining operating profits and wider credit spreads continues to create near-term consternation for weak balance sheet stocks.”

Source: Business Insider

Oh dear… paging the Fed…

• Meanwhile, per IMF September 2015 Fiscal Monitor, Emerging Markets’ corporate debt rose from USD4 trillion in 2004 to USD18 trillion in 2014. Much of this debt is directly or indirectly linked to the U.S. dollar and, thus, Fed policy.

Oh dear… paging the Fed again…

And just in case you think these risks don’t matter, a quick reminder of what Jaime Caruana, head of the Bank for International Settlements, said back in July 2014 (emphasis mine):

• "Markets seem to be considering only a very narrow spectrum of potential outcomes. They have become convinced that monetary conditions will remain easy for a very long time, and may be taking more assurance than central banks wish to give… If we were concerned by excessive leverage in 2007, we cannot be more relaxed today… It may be the case that the debt is better distributed because some highly-indebted countries have deleveraged, like the private sector in the US or Spain, and banks are better capitalized. But there is also now more sensitivity to interest rate movements."

All of which translates, in his own words into

• "Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally."

And as per current QE policies?

• "There is something strange about fighting debt by incentivizing more debt."

Which, of course, is the entire point of all QE and, thus, brings us to yet another ‘paging Fed moment’:

• "Policy does not lean against the booms but eases aggressively and persistently during busts. This induces a downward bias in interest rates and an upward bias in debt levels, which in turn makes it hard to raise rates without damaging the economy – a debt trap. …Systemic financial crises do not become less frequent or intense, private and public debts continue to grow, the economy fails to climb onto a stronger sustainable path, and monetary and fiscal policies run out of ammunition. Over time, policies lose their effectiveness and may end up fostering the very conditions they seek to prevent."

Now, take a look at the lengths to which ECB has played the Russian roulette with monetary policy so far: http://trueeconomics.blogspot.ie/2015/12/31215-85-v-52-of-duration-of-risk.html

3/12/15: 85 v 52: Of Duration of Risk Mispricing

One of the causes of the most recent crisis in the euro area is frequently linked to the superficially low interest rates set by the ECB during the period of 2002-2006. Taking historical average rates, the actual period of significant interest rates deviation from the ‘normal’ was between 38 and 52 months, depending on how you measure it.

Since then, of course we’ve learned the lessons… so the current period of ECB rates below their pre-crisis historical average (using 1/2 standard deviation around the mean to control for significance) is… err… 85 months and counting. Oh, and by magnitude, the current deviation is much much worse than the one that caused pre-crisis mispricing of financial assets and risks.

Just check the following chart, updated to today’s ECB call…

Eye popping, no?.. say 52 months to blow the bubble up… 85 months to… 

3/12/15: Updating that Euro Donkey of Global Growth

While Mario Draghi kept talking justifying the course of ECB policy decisions (or indecisions, as some might want to put), the ECB released staff projections for GDP growth. Here they are, in full glory:

Source: @fwred 

So, that poverty of low aspirations has now been firmly replaced by the circular forecasts: 2015: 1.5% to 1.4% to 1.5%; 2016: 1.9% to 1.7% to 17.%, 2017: 2.1% to 1.8% to 1.9%, whilst inflation expectations are now ‘anchored’ in the proverbial ditch. Meanwhile, Mr Draghi says:

Just as the Euro went through the roof on USD side and with it, Europe's 'exports-led recovery' went belly up.

Though never mind. The bigger headache (that few Europeans can even spot) is that the ECB forecasts are talking about 'growth' at below 2 percent with all this QE and with inflation at extremely low end. Which makes the whole exercise of monetary and fiscal policies activism... err... academic. For as far as I know, no donkeys are allowed to compete in Kentucky Derby. 

26/11/15: Counting Down to ECB's Big Surprise...

Counting the week to December 3rd ECB meeting, I have to ask one simple question: does anyone over in Frankfurt has a clue what they are doing?

Earlier this week, Reuters reported on a conversation with an unnamed ECB source

Here’s what we have learned:

1. Things are far from smooth in the Euro area. We had some serious talking up on Money Supply side earlier this week, and we had incessant chatter about improving credit conditions. We even had promises of accelerated purchases in December (to offset holidays). But the ECB still appears to be directionless in so far as it still views QE road as insufficient. Menu of options is as wide as ever: more government bonds buys, deeper cuts to deposit rates, including a possible two-tier charge, purchases of municipal and regional debt, and even “buying rebundled loans at risk of non-payment has been discussed in preparatory meetings, although such a radical step is highly unlikely for now”. You really have to wonder: do they have any sense of direction (other than strictly forward)?
2. "There are some who say you should surprise markets. But you cannot surprise indefinitely. Sooner or later, you are bound to disappoint." That is per ECB official. Wait a second, sooner or later? Just how many iterations of this circus will we be looking at? ECB’s commitment (rumoured) to push through a major surprise is a desperate bet. If surprise works, markets are likely to overshoot fundamental valuations on all fronts: from EUR/USD and EUR/Sterling to major equities indices and bond prices. But overshooting is not likely to hold unless the ECB continues to surprise the same markets. If, as likely, inflation remains anchored at low levels over the time of these surprises, the ECB will find itself in a situation where the only way to trigger any positive response from the markets will be to double down on every turn. Scared yet?..
3. ”We have deflation, so you have to do something," said a second person. "How this all looks in a few years, nobody knows." And that is the scary bit - it appears that no one is willing to venture a field view deeper than a few months. Back to that directionless driving…
4. Things, however, are clearly not working for Count Draghul: “Failing to [surprise the markets with expanded QE] so risks disappointing investors who expect ECB policy-setters to bolster a one-trillion-euro plus programme of quantitative easing when they meet on Dec. 3, in a move so significant it has been dubbed 'QE2’.” It seems the Euro area monetary policy is now equivalent to showing up in an alligator park with a crate of chickens: the faster you throw them, the closer you get to becoming a meal yourself, yet try not throwing any at all and you are a meal. And as an aside, what kind of a strategist bets on surprise and then pre-leaks all possible routes for such a surprise?..  
5. Meanwhile, the gators are getting a sight of the chicken man slipping into their pond: “One person familiar with the matter said [non-performing loans that ECB might consider buying] could be packaged with more creditworthy loans before being put up for sale [to ECB]. "You could buy rebundled non-performing loans, combined with good loans," said the person. "If we get to that, then things are very bad.”” Oh dear, slice-and-dice tranches of MBS anyone? The ECB is moving closer and closer to tracing Lehman strategy ca 2006…
6. If the ECB does buy municipal and regional debt, we are in yet another fiscal corner. Buying such paper will absolutely nothing to stimulate private sector capex. But it will loosen the purse for local governments, thus undoing all the ECB-led efforts to reign in fiscal profligacy. And, given the horrific state of public finances across the Euro area, it will set up the ECB to support municipals and regions for many years to come.

So for now, we have captain Draghi steering the ship at faster speeds and with greater determination. Except we don't quite have any idea of the exact course. Thursday should be fun…

30/10/15: Eurocoin: Not so Sunny on the Growth Horizon...

Eurocoin - a leading growth indicator for Euro area economy published by CEPR and Banca d'Italia - posted second consecutive monthly decline in October, falling to 0.36 from 0.39 in September and down from the recent peak of 0.43 registered in August. This is the weakest reading for the indicator in 6 months.

For what it is worth, the ECB remains stuck in a proverbial monetary corner:

While in historical terms, growth signal of 0.36% (and annualised average over the last 12 months of 1.58%) is above long term average (annualised average growth over the last 15 years of 1.03% or over the last 5 years of 0.57%), growth remains anaemic by all possible comparatives beyond the Euro area.

You can see the less than pleasant specifics on eurocoin drivers for October here: http://eurocoin.cepr.org/index.php?q=node/243. In the nutshell, things are static across all major sectors, with households' optimism is largely flattening; and if we ignore the European Commission survey signals, things are poor for the industrial sector.

3/9/15: ECB Decides to Not Decide, but Reserves a Right to Decide More

ECB decision to hold rates unchanged at today's meeting was hardly of any surprise. This means there is little news in terms of actual policy actions coming from today's council. Instead, some surprises were delivered by Mario Draghi in his statement. Here is a summary.

Firstly, ECB cut GDP projections for the euro area economy. The ECB now expects euro area GDP to grow 1.4% in 2015 (down on previous forecast of 1.5%); 1.7% in 2016 (down of previous forecast of 1.9%) and 1.8% (down on previous forecast of 2.0%). The miracle of "2% growth next year or next after next" has now been abandoned. As the following tweet sums this up:

We also got revised outlook for inflation and a warning from Draghi that inflation can be low or that we might yet see deflation. ECB now projects HICP inflation at 0.1% in 2015 (previous forecast was 0.3%), 1.1% in 2016 (previous forecast at 1.5%) and 1.7% in 2017 (previous forecast was 1.8%). Which means that the ECB is still sticking to the miracle of "close to 2% inflation a year after next" target. Of course, both sets of revisions mean that declines in forecast growth in nominal incomes are going to be sharper than in real GDP. Which means euro area will get less income, more prices. That, presumably, remains the 'good side of inflation' in ECB's mind.

Draghi warned that the 'there are downside risks to September inflation projections'. Now, who could have guessed as much, given that I posted recently the 5yr/5yr swaps chart clearly showing that euro area inflation expectations in the markets have gone soft once again. Shall we repeat that again?

Source: @Schuldensuehner

Draghi's job today, however, was to talk down the euro. Which he did by simply stating that QE will be running at planned rate (EUR60bn purchases) through planned timeline (to September 2016) and can be extended and expanded if the need arises. Promptly, Euro dropped like a rock.

In a typical, by now ritualistic, referencing of the monetary policy transmission mechanism (still broken), Draghi referenced improved, but still poor credit conditions for euro area corporates. Chart illustrates:

Of course, there is little point of reminding all that growth in credit requires growth in demand. Unless, that is, you are a European policymaker who thinks (as they all seem to be required to do) that issuing loans to companies is a great idea to generate economic growth even if there is absolutely no need for new capacity creation in the economy with stalled demand.

In short, ECB has now reacted to the rot in the Emerging Markets (and in particular China). This is a reactive move with some serious wisdom behind it - the rot is not over yet, by all means and the ECB is out of the gates with signalling that it will continue priming the Government bonds markets pump to prevent any spiking in the rates or euro revaluations derailing already weak exports. With BRIC PMIs signalling ongoing and deepening deterioration in global growth conditions (link here), this is expected and wise. For now, doing nothing new, but promising to do it longer and more aggressively is the preferred response from Frankfurt. It might just be enough.

28/8/15: Central Banks' Activism in a Chart

Having been out of contact due to work and summer break commitments, I will be updating the blog over the next few days with interesting bits of information that have been overlooked over the last 10 days or so. So stay tuned for numerous updates.

To start with, here is a picture of the Central Banks' monetary activism to-date:

Source: @Schuldensuehner 

The chart above sets 2005 = 1000 and indexes the uplift in Central Banks' balancesheets expansions: Fed almost x5.6 times; PBoC almost x6.4 times, ECB almost x2.3 times and heading toward x3.3 times under the ongoing QE, BoJ almost x2.1 times... not surprisingly, the old Fed 'put' is now pretty much every Central Bank's default option...

Much of this mountain of money printing has gone to grease the wheels of sovereign debt markets. Much of the resulting revaluation of financial assets is simply not sustainable under the premise of the Central Banks' 'puts' withdrawal (monetary tightening).

In simple terms, the ugly will get uglier and we have no idea if it will get any better thereafter.

27/7/15: IMF Euro Area Report: Growth, of European Standards

The IMF today released its Article IV assessment of the Euro area, so as usual, I will be blogging on the issues raised in the latest report throughout the day. The first post looked at debt overhang while the second post presented IMF views and data on the euro area banking sector woes.

Here, let's take a look at headline growth outlook.

Based on the IMF view: in the Euro area, "the recovery continues. After weakness through mid-2014, growth picked up late last year and has continued in 2015, driven by domestic demand. Private consumption remained robust, reflecting rising employment and real wages, while fixed investment has expanded moderately. Among the large economies, Germany continues to grow slightly above 1½ percent, while Spain is rebounding strongly. Italy is emerging from three years of recession, and activity in France picked up at the beginning of this year."

This sounds good. Until it ain't. Chart below shows that growth drivers remained in 1Q 2015 the same as in 4Q 2015:

And more: stripping the uplift in inventories, headline GDP growth in 1Q 2015 would have been worse than in 4Q 2014. And, despite collapse in oil (energy) prices and increase in consumption, imports have increased their drag on GDP growth.

Meanwhile, Industrial Production is virtually flat, as is Construction activity:

So the net medium-term result is bleak: "Despite the cyclical upturn, growth of only about 1.6 percent is expected over the medium term, with potential growth averaging around 1 percent. The output gap would close around 2020 with unemployment still near nine percent and inflation reaching 1.7 percent, somewhat below the ECB’s medium-term price stability objective. The picture is more disappointing in comparison to the U.S. with the per capita income gap now the largest since the start of EMU, and projected to widen further."

How much further? Oh, take a look at these:

A positive scenario uplift can only be expected from long-term and painful reforms. IMF lists them here:

"A scenario combining monetary easing, fiscal support under the SGP, and comprehensive structural
reforms would include:

• Monetary easing. Current interest rate policy continues through 2020 and QE through September 2016.
• Fiscal space within the SGP. For the eurozone, fiscal space available within the SGP could amount to 0.6 percent of euro area GDP. This includes (i) room under countries’ Medium-Term Objectives (MTOs) (0.3 percent of euro area GDP); (ii) SGP flexiblity that a few qualifying countries could use for structural reforms (0.2 percent of euro area GDP); (iii) windfalls from lower interest payments due to QE (0.1 percent of euro area GDP) for one-off investments or structural reforms for a few countries already meeting their MTOs; and (iv) growth-friendly fiscal rebalancing for countries with limited fiscal space to lower the labor tax wedge by two percentage points, financed by base-broadening measures.
• Centralized investment. An increase in private investment of 0.2 and 0.8 percent of euro area GDP in 2015 and 2016 is assumed, which is equivalent to 1/3 of the targeted amount of European Fund for Strategic Investments (EFSI) projects.
• Clean-up of bank and corporate balance sheets A fully functioning credit channel is simulated as a decline in corporate borrowing rates, by 80 basis points in Italy, 25 basis points in Germany and France, and 50 basis points in the rest of the euro area. This would bring the spread between selected and core countries roughly to pre-crisis levels.
• Structural reforms. Gradual implementation of product and labor market-related reforms in the 2014 G20 Comprehensive Growth Strategy could increase total factor productivity (TFP) by about 0.1 percent in 2015, 0.5 percent in 2017, and 0.9 percent in 2020. The implied TFP changes would differ substantially among member countries, with France, Italy, and Spain enjoying the largest gains."

So combined effect of the above over the longer term: "The growth dividend of a balanced policy mix can be large. The EUROMOD module of the IMF’s Flexible System of Global Models (FSGM) points to a substantial growth dividend, particularly from fiscal policies and the improvement of the credit channel. Real growth for the euro area would increase by 1.3 and 1.4 percentage points to 2.7 and 3.0 percent for 2015 and 2016, and HICP inflation rate in these two years would rise to 0.6 and 2.1 percent. The output gap would close by the end of 2016, about four years faster than in the baseline, and unemployment would be 0.8 percentage point lower than in the baseline by 2016."

Which is, honestly speaking, laughable because of two points worth noting:
1) There is an ongoing and deepening reforms fatigue which is pushing the reforms horizon out toward the next downturn cycle (in other words, we are unlikely to see majority of real reforms to be enacted before the next recession strikes); and
2) Even with all things going the IMF way, unemployment will remain atrociously high. In other words, growth uptick even in the best case scenario is likely to be largely jobless.

So summary of growth uplift drivers is in the chart below:

Expect the expected: looser fiscal policy being the largest new contributor to growth in 2016; labour markets and product markets reforms being marginal - adding at most 0.25-0.3 percentage points to annual growth rates. The fabled 'credit conditions improvements' (banks doing their bit for growth) is expected to be minuscule (despite all the hopes attached to them by the likes of Irish authorities and all the resources of the state devoted in 2008-2011 to repairing them). And headline growth expectations for baseline scenario still resting at 1.7% and 1.6% GDP growth in 2016-2017.

Here is the summary of IMF projections out to 2020:

Yep, the first line of projections above shows perfectly well the poverty of low aspirations that Euro area has become, while the unemployment rate projections confirm the same. Everything else - all the talk about structural reforms, growth drivers and the rest - is pure unadulterated bull. Even in the age of massive QE, collapsed oil / energy costs, and improvements in [sliding back on] fiscal 'reforms', the euro area remains the sickest economy in the advanced world.

21/7/15: Central Europe's Lesson: Fixed Euro or Floating Exchange Rates?

The EU report on economic convergence of the Accession States of the Central and Eastern Europe (CEE10) makes for some interesting reading. Having covered two aspects of convergence: real economic performance and financialisation, lets take a look at the exchange rate regime impact on convergence.

This is an interesting aspect of the CEE10 performance because it allows us to consider medium-term impact of euro on CEE10. 

Basically there were two regimes operating in the CEE10 vis-a-vis the euro: fixed regime (with national currency pegged to the euro) or floating regime (with national currency allowed to float against the euro).

First, recall, that "out of the five CEE10 countries which have adopted the euro by 2015, four (i.e. Estonia, Latvia, Lithuania and Slovenia) already operated under fixed exchange rate regimes in 2004. In their case, euro adoption did not represent an essential regime change with respect to the role of nominal exchange rate flexibility in the convergence process vis-à-vis the EA12." 

Now, EU Commission would be slightly cheeky in making this statement, since while in the first order effect this is true, in the second order effect (expectations), this is not true - a peg to the euro could have been abandoned in a severe crisis, albeit less easily under the regime of ongoing financialisation of the CEE10 economies via foreign banks lending; however, once euro is adopted, no devaluation is possible even in theory. And this is not a trivial consideration, since policymakers know that should they mess up in the longer run, there will be a risk of peg abandonment, resulting in direct, transparent exposure of their policies-generated imbalances for all to see and in serious embarrassment vis-a-vis their European counterparts. In other words, the threat of devaluation as a feasible option could have actually acted, in part, to make peg regimes more stable.

But let us allow EU Commission their assumption (undefined as such) and chug on...

From EU own analysis: "Based on the GDP per capita in PPS data, there was no significant difference in the speed of real income convergence to the EA12 between fixers and floaters over the past decade, but there was a large degree of heterogeneity within both groups. Rather than the type of exchange rate regime, a more important relationship existed between the speed of catching-up and the initial income level, with less developed countries in general converging at a faster pace. Accordingly, the fastest growing economies were, among the fixers, the three Baltic countries and, among the floaters, Poland and Romania. In addition, Slovakia, which recorded one of the best catching-up performances, floated its currency until euro adoption in 2009 and the bulk of its real convergence over the past decade actually materialised before 2009." 

What does this mean? That nature of growth during the period was similar for floating and fixed regimes: both were driven by catching-up of economies, most notably via capital investment. Being fixed to the euro or not, it appears, had no effect on rates of convergence.

But, remember, euro is about stability, not growth. So the key test, really, is in volatility of convergence path, not the path itself. Per EU Commission: "The real convergence path of floaters was in general smoother than that of fixers. This was mainly due to the more pronounced economic overheating in the latter group prior to 2008, which then also led to a larger set back during the financial crisis." Oops… so staying closer to euro hurts. Having fixed rates, hurts. Bubbles got worse in countries with pegged rates. That is not exactly an endorsement of the euro-led regimes.

There's a caveat: "Nevertheless, fixers were able to again largely close their GDP-gap to floaters by 2012, as they enjoyed an export-led recovery, supported by internal price adjustment, structural reforms and favourable export market developments." Yep, that's right: austerity and re-shifting of economy toward external sectors, rather than domestic demand is the miracle that allowed for the fixed rates regimes convergence. That, plus unmentioned, monetary policy activism. 

Still, the view of boom-to-bust euro-driven economy for the fixed rates regime remains. Not that the EU Commission will acknowledge as much.

"The extent of price level convergence over the last decade mainly reflected differences in the speed of catching-up. That said, the average household consumption price level of fixers remained close to that of floaters until 2008, but it became significantly higher in the post-crisis period, as comparative prices of floaters fell." In normal English: deflation hit fixers, while floaters avoided it. 

Core conclusion (despite numerous caveats): "Floaters appear to have been in general able to benefit from their monetary autonomy to achieve a higher degree of price stability. In the pre-crisis period, faster growth and related overheating gradually drove up inflation in fixers significantly above the average inflation rate of floaters. Subsequently, larger output drops and the inability to depreciate against the euro implied that fixers generally also experienced more pronounced disinflation. From late-2010, inflation in the two groups developed quite similarly on average, but the variance was higher among floaters."

So final note on interest rates. Remember - convergence of rates irrespective of risk is one of the poor outcomes of the euro introduction in the EA12, fuelling massive asset bubbles in Spain and Ireland, fiscal imbalances in Greece and so on. In CEE10: "Over the past decade the benchmark long-term interest rate on government bonds was higher on average for floaters than for fixers, both nominally and in real terms. This is partly a consequence of the higher average public debt level among the floaters, but to some extent it is arguably also related to more exchange rate uncertainty inherent in floating." 

EU Commission grumbling acceptance of reality is almost entertaining: "Generally, it takes longer to regain cost competitiveness via internal price adjustment [something that fixed rates economies are forced to do] than via nominal exchange rate depreciation [something that flexible rate economies have access to] and the initial shock to the real economy is more severe. However, the internal adjustment is more permanent as it requires a structural solution to the underlying problems, whereas the temporary boost generated by nominal exchange rate depreciation can actually postpone the reforms necessary for further sustained catching-up." You'd think that flexible exchange rate economies just can't ever compete with fixed rates economies. In which case we obviously have a paradox: Denmark and Switzerland vs Italy and Spain (or for that matter Belgium and France).

So the core conclusion is simply this: things are complex, but having a peg to the euro looks more dangerous in crises and in bubbles build up stages, than running flexible exchange rates regime. Who would have guessed?..

14/7/15: Arrears on IMF & No Samurai Bonds Trigger: Greek Bridge Financing Update

Yesterday, I covered the possible routes to structuring bridge financing for Greece (see this post with today's earlier update). Via WSJ, here is the list of debts coming due over July-August, inclusive of two payments to IMF that are now in arrears (see IMF statement below):

Source: http://graphics.wsj.com/greece-debt-timeline/

And the IMF statement from last night:

A point to note: Greece redeemed the Samurai bonds (Yen 20bn) yesterday. Which, effectively, means it avoided private sector bonds default trigger.

13/7/15: A Promise of a Deal = An Actual Surrender

So we finally have a 'historic' agreement on Greece. You know the details:

1. Tsipras surrendered on everything, except one thing.
2. One thing Tsipras 'won' is that the assets fund (to hold Greek Government assets in an escrow for Institutions to claim in case of default) will be based in Greece (as opposed to Luxembourg), managed still by Troika (it remains to be seen under which law).
3. IMF is in and is expected to have a new agreement with Greece past March 2016 when the current one runs out. So not a lollipop for Tsipras to bring home.
4. All conditionalities are front-loaded to precede the bailout funding and Wednesday deadline for passing these into law is confirmed. 

Bloomberg summed it up perfectly in this headline: EU Demands Complete Capitulation From Tsipras.

Remember,  Tsipras went into the last round of negotiations with the following demands:

Source: @Tom_Nuttall

And that was after he surrendered on Vat, Islands, pensions, corporation tax - all red line items for him during the referendum.

Reality of the outcome turned out to be actually worse. 

The new 'deal' involves a large quantum of debt (EUR86 billion, well in excess of Greek Government request from the ESM) and the banks bailout funding requirement has just been hiked from EUR10-25 billion to 'up to EUR50 billion', presumably to allow for some reductions in ELA. 

The new 'deal' only promises to examine debt sustainability issue. There are no writedowns, although Angela Merkel did mention that the plan does not rule out possible maturities extensions and repayment grace period extensions. This, simply, is unlikely to be enough.

The 'deal' still requires approval of the national parliaments. Which can be tricky. Here is the table of ESM capital subscriptions by funding nation:

Tsipras also lost on all fronts when it comes to privatisations. In fact, even if the future Government lags on these, the EU can now effectively cease control over the assets in the fund and sell these / monetise to the fund itself. Not sure as per modalities of this, but...

Detailed privatisation targets are to be re-set. Let's hope they will be somewhat more realistic (home hardly justified in the context of the new 'deal'):

To achieve this, EU had to literally blackmail Tsipras by rumour and demands:

Source: @TheStalwart

Source: @Frances_Coppola

And so the road to the can kicking (not even resolution) is still arduous:

 Source: @katie_martin_fxs

My view: the crisis has not gone away for three reasons:

1. Short-term, we are likely to see new elections in Greece prior to the end of 2015;
2. We are also likely to see more disagreements between the euro states and Greece on modalities of the programme; and
3. Crucially, over the medium term, the new 'deal' is simply not addressing the key problem - debt sustainability. 

For the fifth year in a row, EU opts for kicking the same can down the same road. 

11/7/15: Harder Default for Greece, Less Democracy for All

My article on the Greek crisis for Irish Independent: impossible mathematics of debt and the political trilemma of sacrificed democracies: http://www.independent.ie/opinion/comment/expect-a-harder-default-for-greeks-and-less-democracy-for-the-rest-of-us-31368677.html

7/6/15: Greece Needs a Structured Euro Exit: Sinn

As the saying goes... can't have a Greece drama without Target 2 drama... Hans Werner Sinn on Greek referendum results:

In simple terms: make Grexit. As this stage int the game, I agree - facilitated (using European financial and investment supports) exit by Greece from the euro area is the optimal resolution path to the crisis.

The arguments about new costs are irrelevant: Greek debts are currently unrepayable and will not be made good by any structural reforms. In fact, the debts are holding back the effectiveness of such reforms and will likely wipe out all and any benefits of devaluation that can be gained from conversion into drachma. Whether Greece remains in the euro area or exits, either path will require a write-down of more than 30% of Greek Government debt (my estimate - at least EUR125 billion, in line with recent IMF estimate, although my estimation is higher, since the IMF assessment was prepared prior to the Greek economy deteriorating further and the country fiscal position weakening beyond April 2015 assessments) and some additional assistance (in form of investment funds from the EU) to the tune of EUR20-30 billion over 3 years.

The write-downs should be carried out via ECB and monetised as a part of the ECB QE (wiping out the losses) so the only new call on EU funds will be investment funding. Drachma return will have to be used to carry out immediate fiscal adjustment (so there will be plenty of pain and reforms on that front).

Chart below (source: Open Europe) shows the breakdown of Greek debt by holding:

Ex-IMF official sector holdings are at 68%. IMF should, by all possible metrics, take a bath too, but it won't, so the 9% of the total liabilities held by the IMF is not at play. Banks can take a haircut, but that will require recaps (Greek banks) and/or is utterly immaterial in quantum of debt held (1% for Foreign Banks). Other bonds above are predominantly short-term stuff that can be haircut. No matter how you spin the numbers - Eurozone holdings will have to be cut by more than a half.

5/7/15: Votes are in... What's next for Greece?

With over 75% of votes counted in the Greek referendum, 61.6% of the votes counted are in favour of 'No'.

So what's next? Or rather, what can [we speculate] the 'next' might be?

Possible outcome: Grexit

• This can take place either as a part of an agreement between Greece and Institutions (unlikely, but structurally less painful, and accompanied by debt writedowns, a default or both), or
• It can take place 'uncooperatively' - with Greece simply monetising itself using new currency (more likely than cooperative Grexit, highly disruptive to all parties involved and accompanied, most likely, by a unilateral/disorderly default on ECB debt, IMF debt, EFSF debt and Samurai debt. Short term default on T-bills also possible).

Either form of Grexit will be painful, disruptive and nasty, with any positive outcome heavily conditional on post-Grexit policies (in other words, major reforms). The latter is highly unlikely with present Government in place and in general, given Greek modern history.

Grexit - especially disorderly - would likely follow a collapse of the early efforts to get the EU and Greece back to the negotiating table. Such a collapse would take place, most likely, under the strain of political pressures on EU players to play intransigence in the wake of what is clearly a very defiant Greek stance toward the EU 'Institutions' of Troika. 

Key to avoiding a disorderly / unilateral Grexit will be the IMF's ability to get European members of the Troika to re-engage. This will be tricky, as IMF very clearly staked its own negotiating corner last week by publicly identifying its red-line position in favour of debt relief and massive loans package restructuring. The EU 'Institutions' are clearly in the different camp here.

EU Institutions will most likely offer the same deal as pre-referendum. Greece will be 'compelled' to accept it by a threat of ELA withdrawal, but, given the size of the Syriza post-referendum mandate, such position will not be acceptable to Greece.  In the short run, ECB can allow ELA lift to facilitate transition to new currency, but such a move would be difficult to structure (ELA mandate is restrictive) and will result in more debt being accumulated by the Greek government that - at the very least - will have to guarantee this increase.

Problem with Grexit, however, is that we have no legal mechanism for this, implying that we might need a host of new measures to be prepared and passed across the EU to effect this.

Which brings us to another scenario: Status Quo

In this scenario - no player moves. We have a temporary stalemate. Greece will be cut off from ELA and within a week will need to monetise itself with new currency. 

Why? Because July 10th there is a T-bill maturing, default on which would trigger a cascade of defaults. Then on July 13th there is another IMF tranche maturing (EUR451 million with interest). Non-payment of either will likely force EFSF to trigger a default clause. Day after, Samurai bonds mature (Yen 20bn) - default here would trigger private sector default. More T-bills come up at July 17th and following that interest on private bonds also comes up on July 19th (EUR225 million). And then we have July 20th - ECB's EUR3.9 billion due, with additional EUR25mln on EIB bonds. Non-payment here will nearly certainly trigger EFSF cross-default.

Most likely scenario here would be parallel currency to cover internal bills due, while using euro reserves and receipts to fund external liabilities. Problem is - as parallel currency enters circulation, receipts in euro will fall off precipitously, leading inevitably to a full Grexit and a massive bail-in of depositors prior to that. Political fallout will be nasty.

Most likely outcome is, therefore, a New Deal

This will suit all parties concerned, but would have been more likely if Greece voted 'Yes' and then crashed the current Government. This is clearly not happening and the mandate for Syriza is now huge. Massive, in fact. 

So there will have to be a climb-down for the EU sides of the Troika. Most likely climb-down will be a short-term bridge loan to Greece (release of IMF tranche is currently impossible) and allowing use of EFSF funds for general debt redemptions purposes. 

The New Deal will also involve climb-down by the Greek government, which will, in my view, be forthcoming shortly after Tuesday, especially if ECB does not loosen ELA noose. 

Bad news is that even if EU side of Troika wants to engage with Greece, such an engagement will probably require approval of German (and others') parliament. Which will require time and can risk breaking up already fragile consensus within the EU. In fact, only consensus building tendency in the wake of today's vote is for a hard stand against Greece. Even in an emergency, EU is very slow to act on developing new 'bailouts' - in Cypriot case it took almost a year to get a deal going. For Portugal - almost 1.5 months. Urgency is on Greek side right now, not EU's, so anyone's guess is as good as mine as to how long it will take for a new deal to emerge.

That said, short-term approach under the status quo scenario above might work, as long as:

1. Greece engages actively, signalling willingness to deal;
2. Greece does not monetise directly via new currency (IOUs will do in the short run); 
3. IMF puts serious pressure on Europe (unlikely); 
4. ECB plays the required tune and keeps ELA going (somewhat likely); and
5. There is no fracturing of the EU consensus (if there is, all bets are off).

In a rather possible scenario, EU does opt for a new deal with Greece, which will likely involve pretty much the same conditions as before, but will rely on removing IMF out of the equation altogether. In this case, EUR28.7 billion odd of Greek debt held by the IMF gets transferred to ESM. The same will apply to ECB's EUR19 billion of Greek debt. The result will be to cut Greek interest costs (carrot), and involve stricter conditionality and cross-default clauses (stick). Euro area 'Institutions' therefore will end up holding ca 73% of all Greek debt in that case. Terms restructuring (maturities extension) can further bring down Greek costs in the short run. 

The negative side of this is that such a restructuring & transfer will be challenged in Germany and Finland, and also possibly in the Netherlands. 

It is. perhaps, feasible, that a new deal can involve conversion of some liabilities held by the euro area institutions into growth-linked bonds (I am surprised this was refused to start with) and/or a direct conditional commitment (written into a new deal) to future writedowns of debt subject to targets on fiscal performance and reforms being met (again, same surprise here). Still, both measures will be opposed by Germany and other 'core' economies. 

Either way, two things are certain: One: there will be pain for Greece and Europe; and Two: there will be lots of uncertainty in coming weeks.

As a reminder of where that pain will fall (outside Greece):
Source: @Schuldensuehner 

25/6/15: Monetising Greece

Recently, I mused about cash balances in Greece being monetised by the ECB.

Here is some evidence. First Greek holdings of cash:

Next: Eurosystem ELA:

22/6/15: Greece v Great Depression

As every well-baked economist would know, there are many ways to pickle misery. Here's one novel jar from the Bloomberg (http://www.bloomberg.com/news/articles/2015-06-22/greece-is-in-a-worse-spot-than-america-was-in-1933):

The above shows Greek real GDP compared to the U.S.' at the same stage in the Great Depression.

Yeah, I know, Euro with all its promises of stability, prosperity, progress, peace, etc, etc, etc...

21/6/15: ECB ELA for Greece: Welcome to a Daily Drip of 'Solvency'

Two days ago, I speculated on ECB's motives for drip-feeding ELA liquidity provisions to Greek banks (http://trueeconomics.blogspot.ie/2015/06/1962015-greek-ela-and-ecb-whats.html). And I have noted consistently that ELA is now running against available liquidity cushion, meaning Greek banks are now simultaneously, skirting close to ELA limits in terms of

• Eligible collateral, and
• ELA funds available to cover deposits outflows.

So, not surprisingly, two links come up today:

1. Ekathimerini reports that Greek banks have enough ELA-supported liquidity to sustain capital outflows through Monday only: http://www.ekathimerini.com/4dcgi/_w_articles_wsite2_1_20/06/2015_551285 as on the day of EUR1.8 bn ELA extension approved by the ECB< Greek banks bled EUR1.7 billion in deposits, bringing week's total to EUR4.2 billion in outflows, and
2. Reuters report that the ECB has been all along planning to review/upgrade ELA after Monday emergency summit: http://www.reuters.com/article/2015/06/19/us-eurozone-greece-pm-idUSKBN0OZ0DP20150619

Thing is, Greek banks are now solvent solely down to an almost daily drip-feeding of liquidity by the ECB. Which, sort of, shows up the entire charade of the dysfunctional euro system: the pretence of monetary and financial systems stability is being sustained by not just extraordinary measures, but by an ICU-like mechanics of assuring that a patient is not pronounced dead too soon...

19/6/2015: Greek ELA and ECB... What's the Rationale?

The price of getting Greece ejected or pushed out of the euro has now risen once again as ECB added to the ELA provided to Greek banks amidst a bank run that is sapping as much as EUR800mln per day.

In basic terms, ECB is allowing lending via Eurosystem to Greek banks to fund withdrawals of deposits. Once deposits are monetised and shifted out of Greek banks, Eurosystem holds a liability, Greek depositors hold an asset and the latter cannot be seized to cover the former. ECB was very unhappy with doing the same for Ireland at the height of the crisis, resulting in a huge shift of ELA debt onto taxpayers' shoulders via Anglo ELA conversion into Government bonds.

But ECB continues to increase Greek ELA. Why? We do not know, but we can speculate. Specifically there can be only three reasons the ECB is doing this:

Reason 1: increase the cost of letting Greece go. If Greece crashes out of the euro zone, the ELA liabilities will have to be covered out of Eurosystem funds, implying - in theory - a hit on member-states central banks. In theory, I stress this bit, this means higher ELA, greater incentives to keep member states negotiating with intransigent Greece. Why am I stressing the 'in theory' bet? Because in the end, even if Greece does crash out of the euro area, ELA liabilities can be easily written off by the ECB or monetized (electronically) without any cost to the member states.

Reason 2: keep Greece within the euro area as long as possible, thus allowing the member states to hammer out some sort of an agreement. In theory, this implies that the ECB is buying time by giving cash to Greek depositors so they can run, in hope that they continue to run at a 'reasonable' rate (at, say, less than EUR2 billion per day or so). In practice, however, this is a very short-term position.

Reason 3: ECB is monetizing Greek run on the banks in hope that Greece does crash out of the euro. Here's how the scheme might work: increasing ELA for Greece weakens Greek banks and, simultaneously, strengthens the incentives for Greece to exit the euro once deposits left in the system become negligible and the economy is fully cashed-in. On such an exit, Greek residents will be holding physical euros that cannot be expropriated by the Eurosystem, and thus Greece can launch drachma at highly devalued exchange rate, while relying on a buffer of cash in euros held within the economy.

I am not going to speculate which reason holds, but I will note that all three are pretty dire.

Take your bets, ladies and gentlemen.

11/6/15: What Markets Are Pricing in Greece-Troika ex-IMF Standoff

Head on collision warning 1: IMF has now left the 'political dialogue' room where Greece and Troika (pardon, Institutions) have been pretending to negotiate a pretence at a solution: http://uk.reuters.com/article/2015/06/11/uk-eurozone-greece-chance-idUKKBN0OR13020150611

Which brings us to the markets.

CDS-implied probability of default for Greece is now at 82.04%, ahead of Ukraine:

But bond markets seem relatively cool:

Which suggests two things:

1. Markets still anticipate a deal; but
2. Markets also push down expected duration / longevity of the deal and, in case of the deal unraveling, they expect lower recovery rates.

This, amidst continued 'warnings' and 'dire warnings' and 'ultimatums' and 'take-it-or-leave' offers and the rest of warring rhetoric is not a good omen for the crisis resolution.

Even Jean-Claude 'The Rubber Chicken of European Politics' Junker seemed to have given his last push to this: http://uk.reuters.com/article/2015/06/11/uk-eurozone-greece-juncker-attempt-idUKKBN0OR23V20150611?mod=related&channelName=businessNews and failed...