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Overview
• Bunds and Gilts fell, while Italian spreads of longer-dated paper
narrowed, on hopes that the euro area authorities are working up a more
forceful policy response to the debt crisis.
• Tuesday sees Merkel meet Papandreou to discuss Greece’s reforms and
Greece’s Parliament vote on a new property tax. Data-wise, Tuesday
brings surveys of German consumer confidence and UK retail activity.
Euro area
A new plan to halt the crisis?
Deservedly, the weekend's IMF
annual meetings saw euro area
policymakers humiliated, facing
deafening calls from the rest of the
world finally to get to grips with their
debt crisis. And reports suggest that,
shamed into action, the euro area will
soon respond, with talk of an – albeit
still sketchy – new three-point plan
based on:
• A Greek default by the end of the
year, with an eventual 50% haircut
for bondholders allowing Greece to
remain in the euro and continue to
receive official financing;
• A new mechanism, perhaps
involving the ECB, to leverage
EFSF funds and make available
€2trn or more to support euro area
government bond markets; and
• A major recapitalisation of euro
area banks.
If the reports are correct, the new plan
will be adopted at the European heads
meeting on 17-18 October and
presented to appease the G20 heads
meeting in November. And if the
aforementioned three key elements of
the plan are indeed implemented, that
ought to go some way towards
stabilising euro area financial markets.
But will policymakers actually
deliver this time?
Not least after the repeated failures of
the past couple of years, however,
serious doubts have to remain about
whether euro area countries will really
deliver an effective new plan this time
around. Indeed, even if – thanks partly
to the opprobrium heaped upon them
by finance ministers and officials from
around the globe – euro area
policymakers now at least recognise
the need to raise their game, the
political and legal obstacles in the way
of a forceful new policy response still
look extremely high.
Can political and legal
obstacles be overcome?
A massive increase in the EFSF’s
capacity to support bond markets, for
example, would have to be designed
in a way that is both consistent with
the EU Treaties and avoids
inconvenient parliamentary votes. But
whether that is possible has to be in
doubt, not least with the German
Constitutional Court lurking in the
background. Additionally, whether the
ECB would acquiesce to help
leverage EFSF funds is also
debatable. All recent noises from
Frankfurt suggest that the ECB wants
to extract itself from the business of
supporting government bond markets
as soon as possible, and the ECB’s
squeals are likely to become even
louder when the central bank is hit
with a 50% haircut on the €45bn of
Greek debt it owns. Finally, even for
Greece too, the supposed new plan
would not be a panacea, given that a
50% haircut is unlikely to be sufficient
to deliver medium-term debt
sustainability and allow it to regain
capital market access in the near term.
Market relief to be short-lived
After last week’s market trauma,
investors responded positively on
Monday to the revived hopes of a new
plan. However, they have been
repeatedly disappointed by euro area
policymakers throughout the crisis.
And with an eventual major Greek
default now openly discussed and a
near-certainty, while the plan to ringfence
contagion remains half-baked, it
is unlikely to be too long before
investors again lose faith. Over
coming days, we will look for how
domestic politics are likely to play out
in each of the euro area countries,
and will, of course, watch the attitude
of the ECB, to see if this plan is likely
to get off the ground. But detailed
proposals are unlikely to be
forthcoming at next week’s euro area
finance ministers’ meeting, and so
uncertainty will prevail right up to the
conclusion of the October leaders’
meeting.
German sentiment falls
On the data front, meanwhile, a busy
week for sentiment surveys from the
euro area kicked off with the release
of the latest German IFO index.
Having posted a much sharper-thanexpected
drop in August, all key
components fell again in September,
albeit not quite as far as expected. In
particular, the headline business
climate index declined 1.2pts on the
month to 107.5, its lowest level since
June 2010, while the expectations
index declined 2pts on the month to
98.0, its lowest level since July 2009.
At the sectoral level, sentiment
among manufacturers and
construction firms deteriorated further.
And while wholesalers and retailers
were, perhaps surprisingly, somewhat
more optimistic, overall the survey
points to a German economy that is
losing underlying growth momentum if
not, admittedly, yet sliding into
recession.
Tuesday in the euro area & US
The main events in the euro area on
Tuesday will occur in the evening,
when Germany’s Chancellor Merkel is
set to grill Greece’s Prime Minister
Papandreou on his progress in
implementing his reform programme,
and Greece’s parliament is set to vote
on the government’s latest austerity
measure, a new property tax. Earlier
in the afternoon, Juncker, the
President of the Eurogroup of euro
area Finance Ministers, will be
questioned at the European
Parliament, while German Finance
Minister Schaeuble will also be
speaking publicly. Data-wise,
meanwhile, after today’s IFO, there
are more survey results out tomorrow,
with the release of Germany’s GfK
consumer confidence number for
October likely to indicate rising
pessimism among households. And
on the supply side, Tuesday will bring
the first of several Italian offerings this
week, with auctions of 2Y zerocoupon
bonds and bills. Spain will
also be issuing bills, while, at the
other end of the risk spectrum, the
Netherlands is scheduled to auction
3Y bonds.
In the US, meanwhile, Tuesday brings
the Case-Shiller home price index for
July and the Conference Board
consumer confidence survey for
September. In the markets, the Fed is
set to purchase $0.5-0.75bn of TIPS,
while the Treasury will auction $35bn
of 2Y notes. And Fed Presidents
Lockhart and Fisher are scheduled to
speak.
UK
Tuesday in the UK
It was a quiet start to the week in the
UK for economic news, with no
notable new data released on
Monday. So, the first noteworthy data
of the week will be released on
Tuesday in the shape of the CBI
distributive trades survey, which will
provide the first indication of the
strength of retail sales in September.
And it is difficult to envisage the CBI
survey suggesting anything other than
continued weakness in High Street
activity at the end of Q311.
