The stakes are increasing for this week’s EU Summit, the latest in a series of meetings European leaders having been holding to solve the crisis. Even Italy’s prime minister, Mario Monti, has joined a growing chorus of people warning of the apocalyptic consequences should the summit fail to deliver bold moves.
Of course investors have been down this road before, and have routinely been disappointed.
This time doesn’t look to be any different.
A grand solution appears to be more of a pipe dream than a realistic outcome for the Summit, scheduled for Thursday and Friday, Barclays warns. And if the bank’s pessimistic view plays out, Europe’s troubles will continue weighing on stocks, commodities and the euro.
“We believe investors expecting bold moves on euro bonds or a euro wide bank deposit scheme at next week’s EU Summit will be disappointed,” says Sara Yates, currency strategist at Barclays in London.
She says the summit will yield “more strong rhetoric supporting the roadmap toward tighter fiscal integration, rather than the endpoint itself.”
In other words, don’t expect much.
The jawboning has already begun. Over the weekend, German Finance Minister Wolfgang Schäuble said throwing more money at Europe’s debt crisis won’t solve the problems. In an interview with German TV network ZDF (according to Reuters), Mr. Schäuble expressed frustration that Greece hasn’t lived up on its end of the parameters agreed to in exchange for bailout funds.
Expect more chatter similar to this throughout the week, which won’t bode well for markets.
Spanish Economy Minister Luis de Guindos asked for up to 100 billion euros ($125 billion) in a letter to Euro group chairman Jean-Claude Juncker, saying the final amount of assistance would be set at a later stage.
He confirmed his intention to sign a Memorandum of Understanding for the package by July 9 and said the amount should be enough to cover all banks’ needs, plus an additional security buffer.
The EU’s top economic official, Olli Rehn, said a deal on terms for the loan from Europe’s bailout funds could be concluded in a matter of weeks.
The Chicago Fed released the national activity index (a composite index of other indicators): Index shows slower economic growth in May
Led by declines in production-related indicators, the Chicago Fed National Activity Index (CFNAI) decreased to –0.45 in May from +0.08 in April. …
The index’s three-month moving average, CFNAI-MA3, decreased from –0.13 in April to –0.34 in May—its third consecutive reading below zero and its lowest value since June 2011. May’s CFNAI-MA3 suggests that growth in national economic
activity was below its historical trend. The economic growth reflected in this level of the CFNAI-MA3 suggests subdued inflationary pressure from economic activity over the coming year.
With the outcome of the June FOMC meeting settled, we can set our sights on the August meeting. And at this point, the outcome of that meeting is just as hazy as the last. There is once again a wide range of reasonable views, spanning from QE3 at the next meeting until early 2013, or not at all. Calculated Risk reviews the various opinions here. Interestingly, Goldman Sachs, who expected QE3 to be announced last week, has completely changed gears and is no longer expecting QE until next year. This after offering up the possibility of open-ended QE on the eve of the last FOMC meeting!
Goldman’s view is that the extension of Operation Twist was substantive enough to keep the FOMC on the sidelines. CR takes the opposite bet, expecting QE at the August meeting, anticipating a low-bar for additional action. Still, CR makes an important point:
Perhaps an argument against a QE3 announcement on August 1st is there will not be much data released between now and the next FOMC meeting. For employment, the only major report will be the June employment report to be released on July 6th. Also the advance estimate for Q2 GDP will be released on July 27th.
I have tended to argue that the calendar is very important, especially when policymakers are genuinely uncertain of the next most. Absent major financial crisis, they need sufficient data to justify moving, and they just don’t have it yet.
Once again, the weakness developing in the most leading components of U.S. data closely reflects what we’re already seeing in European data. Last week, Markit reported that European output continues in its steepest contraction since 2009. The path of the Flash Eurozone Purchasing Managers Index (PMI) gives a fairly good indication of what we’re likely to observe in less-timely GDP figures as they are released in the coming months. Meanwhile the HSBC China PMI has also dropped below the 50 level that distinguishes expansion from contraction, with the China Manufacturing Output Index falling to 49.1, and the China Manufacturing PMI falling to 48.1.
Last week, the European Central Bank (to the objection of Germany) substantially lowered the quality of collateral that it would accept in return for emergency liquidity loans. This underscores that the European banking system is effectively out of good collateral, which is troublesome given that a recession in Europe is only in its early stage. The markets are gradually figuring out that the near-daily “agreements” to solve the crisis there represent nothing but words, as Germany is unwilling to provide endless transfers to peripheral European countries. Without Germany, every “bailout” package has to be funded by countries such as Italy and Spain, which are the third and fourth largest European countries but are far more suited to receive bailout funds than to offer them.
German Chancellor Angela Merkel explained the entire situation in five words: “Liability and control belong together.” This is a profound phrase, because it also summarizes how the U.S. got into the housing crisis – the government deregulated the banking system and abdicated proper control, while still assuming the liability through deposit insurance and other government backstops. Liability without control leads to disaster.
The only real chance for Eurobonds, ECB money printing, or other joint sharing of liabilities among European countries – at least any plan that would involve Germany – would require European nations to hand over control of their fiscal policies to a central European authority. That’s not impossible, but it seems that conditions would have to be near-catastrophic for individual countries with very diverse national identities to surrender that much sovereignty. Alternatively, conditions would have to be near-catastrophic for Germany to capitulate and provide endless bailouts to peripheral Europe without this control.
What can Europe do? SocGen has a handy little chart:
With the outcome of the June FOMC meeting settled, we can set our sights on the August meeting. And at this point, the outcome of that meeting is just as hazy as the last. There is once again a wide range of reasonable views, spanning from QE3 at the next meeting until early 2013, or not at all. Calculated Risk reviews the various opinions here. Interestingly, Goldman Sachs, who expected QE3 to be announced last week, has completely changed gears and is no longer expecting QE until next year. This after offering up the possibility of open-ended QE on the eve of the last FOMC meeting!
Goldman’s view is that the extension of Operation Twist was substantive enough to keep the FOMC on the sidelines. CR takes the opposite bet, expecting QE at the August meeting, anticipating a low-bar for additional action. Still, CR makes an important point:
Perhaps an argument against a QE3 announcement on August 1st is there will not be much data released between now and the next FOMC meeting. For employment, the only major report will be the June employment report to be released on July 6th. Also the advance estimate for Q2 GDP will be released on July 27th.
I have tended to argue that the calendar is very important, especially when policymakers are genuinely uncertain of the next most. Absent major financial crisis, they need sufficient data to justify moving, and they just don’t have it yet.