Revenge of the PIIGS

Overnight, markets received a boost from OPEC member’s declaration that they’ll fill any existing or potential supply gap. Later, there was some doubt about the veracity of the claim. The energy complex nonetheless retreated a little, as did gold, and equities jumped. Metals were sold off early then bounced to be even.

However, other markets remain on alert. Grain futures were pummelled again and the $US showed more strength.

There was limited news flow on Libya, with hopes, seemingly, of Gaddafi running. Some revolutionary rumblings are now apparent also in Kuwait but look preliminary, to say the least.

The big news, as predicted yesterday, is Europe. The PIIGS find themselves once again at the centre of a bond panic. Greece, in particular, was crushed, it’s ten year bond rate went parabolic, up over 4% in the session to a new high. EU members appear unconcerned and unprepared. From the WSJ:

Market expectations that Europe’s leaders will agree on a strong and flexible bailout fund to resolve the continent’s debt crisis aren’t likely to be met, said two senior government officials from within the currency area.

The proposals to beef up the European Financial Stability Facility, or EFSF, are encountering growing German intransigence after Berlin failed to achieve its own agenda for reforming euro-zone economies,

In recent meetings, German officials have shown an increasing unwillingness either to strengthen Europe’s temporary bailout mechanism or to augment its powers, as Germany is forced to compromise on its own program to revamp European Union budget rules it sees as vital to boosting competitiveness.

“There will be an agreement because one has to be reached. But I fear that it will not stand up to market expectations, and this could intensify debt problems in the euro zone in the future,” said a senior euro-zone government official who is party to the talks.

“Germany will likely get less than expected in the competitiveness pact so, it will give less as far as the EFSF is concerned. And this is where the problem lies.

The EFSF, which expires in mid-2013, has been set up for €440 billion ($615 billion), but its effective lending capacity is seen at around €250 billion, in part because of the aspiration to reach a triple-AAA rating for bonds raised by the facility. The EU provides another €60 billion to the current rescue fund.

To ensure the new, post-2013 rescue mechanism will have €500 billion available in aid if needed, Germany and other states will have to contribute more.

Euro-zone leaders are due to meet March 11 to discuss Germany’s reform proposals in a run-up to a EU-wide summit March 25 that is being billed as a comprehensive response to Europe’s debt crisis.

Perhaps EU banks have accumulated enough capital to take some losses now. But I sorely doubt it. Paul Mason of the BBC sums it up nicely:

As I’ve reported before, this is building to a climax that will begin at the end of this week, and needs to come to some denouement before the summer. Ireland’s new coalition will head to Budapest to try and renegotiate the bailout terms; Portugal’s refusenik government will come under pressure to seek a bailout and in Greece they will struggle to hold the line against default. It was under-reported but the general strike in Greece, late February, was pretty strong and wider social unrest is simmering.

The USA doesn’t have much more it can do, policy wise, but its palliatives finally seem to be working – fiscal stimulus money and QE are having both domestic and global impact, with the first good news on the jobs front finally coming through.

It’s the Eurozone that is in a bind: Barcap’s economist refer to it as a “different planet”. It is about to face an inflationary spike with a policy regime that is monofocused on inflation – so the ECB will hike rates just to prove it has the guts to do so. This will increase the pressure on peripheral governments to renegotiate the bailout terms, and banks of Germany, Britain and France may finally lose some money in the form of haircuts, repayment delays or even, if it gets chaotic, defaults.

Indeed. Whilst I agree with Martin Wolf today, that the euro is not at risk of disintegration, there’s a battle royal under way in markets between growing prospects for sustainable growth in the US, the oil price and European debt woes.

Combine an unfolding EU liquidity/solvency crisis with the ongoing and unpredictable MENA oil shock, and I conclude that the $US is increasingly likely to be seen as a safe-haven. If it rallies, as I’ve explained before, US growth comes into question.

My fellow blogger, Deus Forex Machina, has a must read post today on the relationships between oil, the $US and the Aussie. In it he argues that it is global growth expectations that governs the strength of the $US.

I agree, and despite today’s equity rally, think there’s a high risk that those expectations are about to get hit.

P.S. After some mockery from my fellow bloggers for my florid language yesterday, I should clarify and say that I’m still of belief that global growth will get through this crisis, but not unscathed, nor without the odd sell-off.

David Llewellyn-Smith
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