If fear of Europe-wide financial wildfire was Athens’ trump card in its standoff with euro zone creditors – then the card has now turned up a dud.
The merits of ruling socialist party Syriza’s demands aside, its brinkmanship in renegotiating the painful terms of its international bailout always required one key element – a financial version of the old Cold War doctrine of ‘mutually assured destruction’.
A reprise of 2010/2011 would have seen any threat of Greek default or euro exit infecting markets everywhere and sending government borrowing costs across Italy, Spain, Ireland and Portugal soaring, heaping pressure on the Eurogroup to move closer to Athens’ demands to prevent a systemic euro collapse.
“Whoever gets scared in this game loses,” Greek Prime Minister Alexei Tsipras said this week as a three-month impasse threatens cash shortages ahead of critical debt repayments.
But the much-feared financial contagion – dubbed ‘euro crisis 2.0′ by forecasters at the turn of the year – has not materialized for euro zone governments sitting across the table.
And few if any investors expect the talks to be electrified by any sudden market blowout – eye-watering gyrations in local Greek markets notwithstanding. Borrowing costs across the euro zone hover near record lows, euro zone equities are within a whisker of 7-year highs and the euro currency has held in a five-cent range for two months.
That’s all the more remarkable given how negative markets have turned on the outlook for Greece itself.
Almost half of all investors polled by German research group Sentix this month expect Greece to leave the single currency within 12 months, while the survey’s index measuring the risk of contagion to other parts of the euro zone fell to a record low.
“Greece is not capable of derailing the euro zone recovery nor is there a real risk of contagion to the periphery,” reckons Wouter Sturkenboom, strategist at the $272 billion asset manager Russell Investments.
Most scenarios sketched by banks and fund managers still center on some progress in talks or some protracted limbo involving some limited Greek default within the zone.
But even though exit is now a real risk, the gloomiest forecasts look mild compared to the chaos of three years ago.
Goldman Sachs says ‘Grexit’ – which they don’t expect to happen – could see Italian and Spanish 10-year bond premia over Germany more than trebling to as much as 400 basis points.
That’s about 200 basis points shy of peaks hit during the winter of 2011/12. And given German 10-year borrowing rates are near zero, those spreads would imply nominal borrowing costs for Italy or Spain 300 basis points below peaks of three years ago.
Critical is the fact that foreign private exposure to Greek assets has dwindled since the default of 2012 and the bulk of Greek debts are now owed to other euro governments, the ECB and International Monetary Fund.
But regional calm is mainly thanks to several euro-wide emergency firewalls – such as the European Central Bank’s Outright Monetary Transactions or the European Stability Mechanism – built painstakingly over the past four years.
Chief among them is the trillion euro bond buying, or ‘quantitative easing’ program launched just last month.
“QE is probably the primary defense against contagion,” Deutsche Bank economist Mark Wall told clients.
By accident or design, the ECB’s rationing of QE via its so-called ‘capital key’ has an in-built stabilizer of its own.
That model means the ECB is set to buy more bunds than anything else with its 60 billion euro per month splurge to September 2016. But, partly as a result, three quarters of all bunds now yield less than zero and a quarter of that universe is illegible for QE purchases because yields are under the -0.2 percent threshold below which the ECB refuses to buy.
That has two implications. Any prior euro shock typically herded euro domestic investors to the perceived safety of bunds. Now they face blindingly expensive securities that even bond guru Bill Gross last week called the ‘short of a lifetime’.
But more powerfully, the growing inability of the ECB to buy bunds will likely force it to alter its capital key and skew purchases more toward the large, higher-yielding peripheral bond markets of Italy and Spain – further protecting these markets in the event of any Greek shock in the interim.
Without a spike in borrowing rates, shocks to business confidence and investment that whacked equity markets last time round are muffled.
It’s possible mutual or hedge funds shift money out of the bloc altogether. But the main result of that would be pressure on an already weakened euro exchange rate – a move likely cheered rather than booed in the rest of Europe as it underpins economic recovery and wards off deflation.
Some say the bigger risk from Syriza’s rise to power was political rather than financial contagion – emboldening anti-austerity movements across Europe, such as Podemos in Spain, and stoking euro scepticism and existential threats to the currency.
But chaos in Greece, no financial shock elsewhere and no concessions from Brussels could well have the opposite effect.
“There is no other Greece and there isn’t quite another Syriza,” JPMorgan economists told clients, pointing out the only popular anti-austerity party seeking euro exit was Italy’s Northern League. “The disorder unleashed by Greece’s exit would probably dampen support for these parties and reduce rather than increase the odds that others follow its lead.”
Source: Reuters (Graphic by Vincent Flasseur and Marius Zaharia; Editing by Anna Willard)
Fed: Slowdown Due to Transitory Factors
Federal Reserve officials attributed the economy’s sharp first quarter slowdown to transitory factors, in effect signaling an increase in short-term interest rates remains on the table for the months ahead although the timing has become more uncertain.
The Fed now needs time to make sure its expectation of a rebound proves correct after a spate of soft economic data. That means the odds a rate increase by midyear have greatly diminished, a point underscored by the Fed’s statement released Wednesday at the conclusion of a two-day policy meeting.
“Economic growth slowed during the winter months, in part reflecting transitory factors,” the Fed said. The Fed also said that although growth and employment had slowed officials expected economic activity to return to return to a modest pace of growth and job market could continue to improve, “with appropriate policy accommodation.”
The gathering concluded a few hours after the Commerce Department reported the U.S. economy grew at a 0.2% annual rate in the in the first quarter. It was the worst performance in a year, pocked with evidence of a slowing trade sector and anemic business investment. The report also showed annual consumer price inflation slowed in the first quarter.
For now, the Fed isn’t signaling any shift in its policy stance. It repeated it would keep its benchmark short-term interest rate, the federal funds rate, pinned near zero, where it has been since December 2008. Officials in March opened the door to rate increases later this year, by removing from the policy statement assurances rates would stay low.
The policy statement said, as it did in March, that the central bank would raise rates when officials become reasonably confident that inflation is moving back up toward the Fed’s 2% objective and as long as the job market continues to improve.
Officials sought to acknowledge the recent economic downshift in their policy statement, while keeping their options open. The pace of job gains moderated, the Fed statement said, and measures of labor market slack were little changed. Business investment softened and exports declined.
The statement also said officials saw the risks to the outlook were balanced — an important sign that they aren’t at this point alarmed about the first quarter slowdown. Many officials believe that conditions are ripe for consumer spending to pick up in the months ahead, in part because employment, incomes and confidence have risen and falling gasoline prices have boosted household purchasing power.
The statement pointed to strong gains in inflation-adjusted household incomes and consumer sentiment, underscore this view.
Nobody dissented at the meeting. It was the fifth time in 10 meetings run by Fed Chairwoman Janet Yellen with no dissents.
The Fed’s assessment of the economic backdrop was in some respects similar to its assessment at its March 2014 policy meeting. Then as now the economy appeared to have stumbled during cold winter months. This time the temporary headwinds included a strike at West Coast ports in February.
Fed officials thought the 2014 slowdown was a temporary blip and in that case proved to be right. Economic growth picked up in the second and third quarters of last year.
This time, however, the backdrop is more complicated. Falling oil prices have crimped investment in the nation’s oil patch, evidenced by falling rig counts in places such as Texas and North Dakota. Moreover, a surging dollar is putting downward pressure on import prices and restraining inflation, in addition to pushing up the price of exports and hurting the trade sector.
The Fed said, as it has before, it expects the economy to resume growth at a moderate pace and inflation to gradually rise back toward 2%.