The Eurocrisis has been on hiatus for a few days but returns this week. Look for nothing to be resolved while the crisis keeps plodding along.
Italian Elections. Who knew Italian elections could be so much fun and so confusing? An interesting situation has arisen in the aftermath of voting that will undoubtedly be studied in universities around the world during classes on game theory. The election has split three ways. If any two parties decide to work together, they can form a government. A will work with C, but not with B. B has not ruled out working with either A or C, but they have vowed not to work with B. C won’t work with anybody. What happens next?
Bond markets are pricing in a grand coalition government between, A and B, Bersani and Berlusconi. If this scenario begins to fade, Italian bonds yields will rise. Once they reach unacceptable levels, Bersani will back off his vow never to work with Berlusconi. This government will prove to be weak, and a second round of elections will merely be delayed.
Cyprus Bailout. There are sticking points in negotiations that we reviewed previously in Key Cyprus Bailout Issues. Suffice it to say, that Cyprus will get its money and Germany its face-saving conditions. These will include budget cuts that will worsen the Cypriot recession and remedies to stop Cyprus from laundering money. The latter will destroy Cyprus’ most reliable money-maker, so no one knows how it will pay off its debt to move from 140% of GDP after its proposed bailout to 100% by 2020. Don’t count out the troika. It has the tool guaranteed to make the numbers work— a spreadsheet with fantastic economic growth projections. It worked for Greece and will work for Cyprus.
In the meantime, bailout “negotiations” will take a few months to persuade Cyprus to “agree” to the conditions. Expect the ECB to finance Cyprus until the 1st bailout package becomes effective using the ELA program just like it did for Greece during its inter-bailout periods.
Rising Eurozone Unemployment and Economic Contraction. Despite what you may have read in the mainstream media, there are no prospects of a European turnaround in the cards for the second half of the year.
Economic forecasts are reliable for ninety days out. After that, economists do no better than chance in forecasting. Economists see the recession continuing through the next quarter with growth finally asserting itself in the third and fourth. Take those forecasts with a grain of salt as the second half of the year falls outside the 90-day accuracy window.
Europe’s internal demand shows no signs of revival, so growth in the third and fourth quarters will have to rely on an export driven boom to the United States and China. If the economic activity in these countries does not pick up significantly, then Europe will at best remain stagnant in the second half.
ECB Put. With economic contraction, high unemployment and no political progress accomplished on a closer union, the only thing keeping the Eurozone on the rails is the ECB Put. As long as the OMT is not tested, it should continue to act as a guarantee on the value of periphery debt.
The problem with OMT is that the program is treated by investors as being unconditional support for periphery bond prices; however, the program actually is conditional upon implementing tax increases, budget cuts and severe labor market reforms. What happens when a country refuses to accede to the conditions? We may find out if the Italian stalemate continues.
Happy Talk. None of these facts matter as Wolfgang Schaeuble continues his masterful spin of the crisis:
We haven’t turned the corner yet, but we’re on a good path…It would be wrong at this point to change course.”
Unemployment continues to increase, GDP to decrease and crisis countries budget deficits are growing. What would the bad path look like?