MUNICH—European markets took a breather last week as the outcome of the Greek elections resulted in a new government that is in favor of continuing the path that has been laid out by European institutions, or more colloquially referred to as the pro-bailout parties.
New Democracy leader Antonio Samaras was sworn in as the leader of a new Greek government, which has a comfortable majority in Parliament. Nonetheless, even the new coalition parties, in the wake of the Spanish bailout, will push for a softening of the rules set forth by the European Union (EU), European Central Bank (ECB), and the International Monetary Fund (IMF).
Greece is expected by the Troika to cut public spending to a level that would let it reduce its staggering public debt figure.
This agreement did not prevent the new government from announcing last Thursday that it would expect to renegotiate the cut in the minimum wage, public sector job cuts, and public sector wage cuts in the near future. A denial of this request was promptly issued by Dutch Finance Minister De Jaeger and German Chancellor Angela Merkel.
Despite these slight troubles, markets took the news of a pro-bailout government as a positive and held on to their gains of the previous weeks.
The EURO STOXX was up a modest 0.25 percent to close at 2,186 points. The euro already had quite a bounce the week before last and consolidated the gains, losing 0.53 percent to close at 1.26, which given the recent volatility cannot be considered a heavy move.
Despite the positive performance, Citigroup chief economist Willem Buiter leaves room for concern as he points out the dismal track record of Greece’s keeping its promises and the increased likelihood that the Troika will lose its patience. He writes in a Financial Times op-ed published last week: “We consider it highly unlikely that Greece will comply sufficiently with even ‘lite’ fiscal austerity conditionality, let alone with structural reform conditionality, including privatization targets, which are unlikely to be relaxed. Political opposition to both austerity and reform now are stronger in Greece than ever before.”
Spanish Bank Stress Test, German Economy
Germany is perceived to be in the driving seat of eurozone bailout negotiations as it is the nation who is footing most of the funding support and has the strongest economy. Germany, however, is not independent of the European periphery as well as economic performance in China and in the United States. Since Germany exports heavily into all these markets and since those countries recently all hit a patch of slow growth it is hardly surprising that the Purchasing Managers’ Index (PMI) released last week did not present a good showing.
The forward looking surveys of both manufacturing and services PMI both missed estimates of 45.2 and 51.5 to print 44.7 and 50.3, respectively, marking a three-year low for German PMI data. Readings below 50 signal contraction and given the fact that the GDP of the eurozone barely managed a flat reading last quarter with Germany being the last man standing to prevent a recessionary reading, it is highly likely that the third quarter will again show negative growth for the eurozone as a whole.
Meanwhile, in Spain, the much-anticipated independent assessment of capital need for the country’s banking sector was published by consultants Oliver Wyman and Roland Berger and the surface results were quite in line with expectations.
In the worst case scenario—assuming a decline in Spanish housing prices of 19.9 percent this year—the banks are expected to lose between 253 and 274 billion euros ($318 billion and $344 billion) on their real estate loan books. According to the analysis, however, the total capital need for the 14 largest Spanish banking groups was only 51 billion–62 billion euros ($64 billion–$77 billion) in the most adverse of scenarios and well below the agreed upon European Union support of 100 billion euros ($125 billion).
This is only possible as the consultants factor in several capital accretive items that are highly questionable. While 98 billion euros ($123 billion) in already accounted for provisions do indeed provide a welcome buffer for losses, the study also talks about a 33 billion–39 billion euro ($41-49 billion) capital buffer the origin of which—given the necessity of EU capital support and stretched Tier-1 ratios—is much less clear and the study fails to provide adequate detail in that respect.
The same is true for an expected amount of 64 billion–68 billion euros ($80 billion–$85 billion) in new profit generation. Given that the entire market capitalization of the Spanish banking sector according to MSCI is only 92 billion euros ($115 billion), this would imply a 73 percent return on equity, a completely unrealistic figure in the best of times. Again the study fails to provide adequate detail as to how these figures will be achieved in a declining macroeconomic environment.
The Week Ahead
The EU summit on June 28 will likely be underscored by rumors of a banking union that could solve the problem of deposit outflows from the periphery to the core. As it is the case most of the time with EU summits, any resolution will probably be light on details.
Germany will release retail sales, unemployment, and consumer confidence figures, which will probably follow the PMI data and not come out too strong.
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