In June last year the single currency stood on the edge of the precipice as bond yields for Italy and Spain soared to multi month highs, and Greece continued to look as if it could well leave the euro.
The contrast to how markets were looking twelve months ago could not have been greater as markets digested the soothing effects of the first of two LTRO’s and bond yields started to slide back in a fairly calm December and January. Scroll forward twelve months and we have the same calm as once again markets digest the latest measures from the ECB to deal with the crisis in Europe.
It was also just over a year ago Angela Merkel pushed through the much vaunted fiscal compact and the launch of the ESM was brought forward to 2012, in response to concerns about the sustainability of the European project.
Despite warnings that the LTRO’s would only provide a short term placebo to markets and actually make the feedback loop between banks and sovereigns more toxic, European politicians started to congratulate themselves on their ingenuity in averting a potential disaster.
Twelve months on and you would be forgiven for thinking that some EU politicians would have learnt from last year’s events, however it seems that Olli Rehn hasn’t, after his remarks that the Cassandras who predicted that the euro would break up have been proved wrong.
While that may be true in the near term the actions by Europe politicians have done little to solve Europe’s underlying deep seated problems.
The eventual granting of Greek aid to the tune of €34bn also saw Greek Prime Minister Samaras Antonis Samaras declare “Grexit” talk well and truly dead. Those remarks could well come back to haunt him as opinion polls show the government rapidly losing support.
EU politicians certainly have an awful lot to thank the ECB for after the bank was finally forced, almost kicking and screaming, and despite Bundesbank objections, to promise to intervene on an unlimited basis, with a new OMT program which promised to support countries on an unlimited basis in return for fundamental economic reforms.
Since ECB President Draghi’s comments last June that the ECB would do whatever it takes to preserve the euro, and “believe me it will be enough” markets have been reluctant to test that resolve, however that could well change as we head into 2013 and economic data continues to disappoint.
Draghi has done a brilliant job in buying EU politicians more time to address the problems in their respective economies, however the main problems remains unresolved. Growth is falling with the EU currently in recession and unemployment is rising sharply across the board, while the one economy that has consistently outperformed in the past two to three years is also slowing down.
The sharp growth downgrade for 2013 by the Bundesbank for economic growth in the German economy could well be a problem for Angela Merkel in what is an election year for the German Chancellor, as German taxpayers start to tire of writing blank cheques for European bailouts.
It seems once again that some EU politicians are celebrating prematurely and basking in complacency as fragmentation of the euro area remains all too real.
The German Chancellor, Angela Merkel, unlike her finance minister, has no such illusions and remains all too aware that risks remain, however her room for manoeuvre remains extremely limited due to this year’s German elections.
It remains likely that Merkel will probably get re-elected later this year, but that’s probably only because there is no credible alternative. With that in mind while Germany has been pushed into ceding some ground with respect to the Greece bailout, any further bailouts or policy softening remains unlikely ahead of this year’s election.
Greece’s debt still remains unsustainable, even under the new bailout terms, given that there will be new austerity measures this year, and it seems likely that the economy will continue to contract and unemployment will continue to rise, further eroding social cohesion in a country in its sixth year of depression. The key question remains as to how long the government can survive the implementation of fresh austerity measures in the face of continued public opposition.
Spain’s reluctance to ask for a bailout could well be tested early this year, despite seeing the Spanish bad bank being set up with an initial cash injection of €37bn.
The question is will that be enough with distressed loans currently running at over €180bn, and unemployment continuing to rise, while house prices continue to fall. In Q3 Spanish house prices fell 3.8%, making it a 15.3% annualised fall, suggesting that this figure will continue to deteriorate further hampering Spain’s economic recovery, and making it likely that bad loans will continue to soar.
Any bailout request is likely to come with conditionality attached to it and Spanish PM Rajoy will struggle to convince EU leaders he can deliver the required conditionality when he can’t even impose it on his spendthrift regions.
If that wasn’t enough to worry about the election of a new Italian government at the end of Q1 this year could well throw a spanner in the works with respect to the speed and implementation of the current reform program.
Even if current poll leader Bersani gets elected, pushing on with further reforms will depend largely on the political make-up of the next Italian parliament, with Mario Monti set to throw his hat into the ring the political dynamics could well prove to be very interesting. The success of new reform programs will also depend on politicians’ willingness to impose further austerity on a country already seeing unemployment well above 10%, and youth unemployment at 35%.
In conclusion while President Draghi has taken euro break up risk off the table in the short term, which has proved to be euro positive, the fact remains that for Europe to transition through the next few years the currency needs to be much lower to help the fiscal transition, while local populations also need to buy in to the final end game of reduced local sovereignty. On that last point there is no evidence that populations are willing to do that, and that above all else is a huge hurdle to overcome.
Initial indications suggest that creditor countries have limits to the depth of their pockets with respect to bailout funds, and debtor countries have limits to the extent of the austerity imposed on them as the price for being in the euro, given the social unrest seen in Greece and Spain as the crisis continues to bite.
As such the break-up or fragmentation risks remain in the long term and even though the risks are political in nature, they still remain real, given that the solutions so far being imposed continue to lack democratic legitimacy, with respect to increased EU budget interference, and political pushback at a local level to the austerity policies being imposed by the troika in return for participation in any aid programs.
With this in mind the current rise in the euro could well see further gains towards 1.3500, which is 61.8% retracement of the 1.4940/1.2045 down move in the event of a break above 1.3310. For the current uptrend to unwind we need to see a long term break below trend line support at 1.2940, from the 1.2045 lows.