AMSTERDAM—Last week saw markets recover a bit after the previous week’s rout, but the situation remains precarious and volatile in the Eurozone.
The EURO STOXX gained 0.86 percent to close at 2,311 last Friday. The euro currency gained 0.91 percent, closing at $1.3197. One of the reasons for a relatively higher strength in the euro versus equities last week and the week before is the phenomenon of repatriation of funds.
In times of increased stress and volatility, banks and other financial markets players need to reduce risk exposure. They oftentimes cut their foreign exchange denominated assets to reduce the fluctuation of their trading books due to moves in the exchange rate. This has the counterintuitive effect that the euro strengthens at a time when it is perceived safer to hold U.S. dollars.
Spain was again at the epicenter of the risk-off trade with the Madrid Ibex index dipping below 7,000 and briefly trading lower than even March 2009 at the depth of the Great Recession. As a comparison, the S&P 500 index of the 500 biggest listed corporations in the United States went up by more than 100 percent since March 2009.
Loan data released by the bank of Spain might have been responsible for the rout in Spanish markets and a rise of the 10 year Spanish government bond above 6 percent, albeit briefly. For the first time since October 1994, bank loans that were at least three months overdue were higher than 8 percent of the total 1.76 trillion euros ($2.32 trillion) or 143.8 billion euros ($189.77 billion) based on data at the end of February 2012.
Spain is suffering from a real-estate collapse of U.S. subprime proportions and many of the impaired loans have not been written down by the country’s banks nor have they been properly provisioned for.
Spanish Bond Auction Mixed as Economist Predicts Bail Out
Spain auctioned off 2.5 billion euros ($3.29 billion) in 2-year and 10-year bonds to good demand. The so-called bid-to-cover ratio indicates how big the volume of bids by market participants was as opposed to the amount on offer. This time, the ratio increased to 2.42 compared to 2.17 at the January auction. The bids that are tendered above the required amount usually demand quite a high yield and are therefore not filled.
The problem with this auction was that even the bids that were served required a yield that was 0.35 percent higher on average than at the auction in January, prompting some commentators to label the auction a failure. Spanish equities and the euro lost some ground straight after the auction corroborating this view.
Citigroup’s economics team, headed by Willem Buiter, expects that Spain will be forced to accept a bailout by the European Union (EU), the International Monetary Fund (IMF), and the European Central Bank (ECB) later this year. “The EMU [economic and monetary union] crisis remains unresolved and the short-term liquidity support for periphery EMU sovereigns from the ECB’s 3-year LTROs is probably past its peak. We expect that Spain will enter a Troika program this year, most likely focused on recapitalizing and restructuring the banks.”
First French Election Results Confirm Socialist Hollande Front-runner
The socialist candidate Francois Hollande won 28.4 percent of the votes during the first round of voting last week and will now face incumbent conservative President Nicolas Sarkozy who collected 25.5 percent. The run-off vote is scheduled for May 6.
Hollande is perceived by many market participants as being less bank and euro friendly than Sarkozy. Also, the partnership between Angela Merkel, Germany’s chancellor, and her new French counterpart will have to be redefined. Previously, Sarkozy and Merkel could work reasonably well together. The yield differential between German and French government bonds increased to levels above 2 percent, a level not seen since January.
The socialist candidate wants to change the EU’s fiscal compact, a program to reduce government deficits by including provisions for pro-growth spending. He also wants to separate retail and investment banks echoing the U.S. Glass-Steagall Act from 1933. Other proposals include a 15 percent higher corporate tax for banks and up to 75 percent income tax for incomes higher than 1 million euros ($1.32 million).
While Sarkozy has not lost the vote yet, the first round puts him at a big disadvantage over Hollande whose victory could create even more volatility in already fragile European markets.
The Week Ahead
Italy, Germany, and the Netherlands will all auction off bonds and bills, which will be closely watched by the markets after last week’s volatile Spanish auction. Markets will likely calm down a bit if central banks around the world reiterate their dovish policy stance. If not, volatility is apt to continue for the time being.
In addition, there will be economic data releases, namely French, German, and eurozone Purchasing Managers’ Indices (PMI) as well as German consumer prices and a eurozone business climate indicator.
The focus will probably continue to be on Spain, which will also release retail sales figures for February and the unemployment rate for the first quarter.