With most of Europe away on holiday in August, big developments in the eurozone (EZ) were few and far between. Now that policymakers, traders and investors are back in the saddle, however, September promises to be a dramatic month in the common currency area. Here’s a look at the dates offering potential flashpoints.
This month kicks off with today’s European Central Bank (ECB) governing council meeting. At the August meeting, ECB President Mario Draghi said that the ECB might be willing to reactivate the Securities Markets Program (SMP) to buy bonds at the short end of the yield curve for those countries that have submitted to the conditions attached to European Financial Stability Facility (EFSF)/European Stability Mechanism (ESM) assistance. In the meantime, a number of rumors have sprung up that the ECB will engage in yield or spread targeting. Peripheral bond yields have fallen significantly since Draghi’s August announcement, suggesting that investors believe the rumors are true. There is so much upside risk priced into the markets now, the room for disappointment is significant.
Hopes are high for what the ECB might announce. The danger is that anything short of the “full monty”–explicit yield or spread targets with unlimited bond purchases — would be considered a disappointment and will inspire a sell-off just as we enter an extremely turbulent month.
Today’s meeting is not the only event to watch this month.
With most everyone back from summer holidays, the Italian general election campaign will begin in earnest in early September for the election that will be held by the end of April 2013. Although polls point towards a center-left led coalition, Italian politics is at its most fluid state since the early 1990s, and with so many voters still undecided, it is impossible to call the election. Silvio Berlusconi and Beppe Grillo will be running on Euroskeptic campaigns, which could raise concerns about Italy’s dedication to implementing difficult measures in order to remain in the eurozone.
On September 7, the so-called troika – the ECB, European Commission and International Monetary Fund (IMF) – will arrive in Greece to make a ruling on if they should release additional tranches of funding to the struggling country. Before additional funding is released, , Greece must present its plan for generating an additional EUR11.5-14billion in savings to get back on track to hit the fiscal targets stipulated in the second bailout program. Prime Minister Samaras and Finance Minister Stournaras have identified a number of measures to generate these savings. First, they have to sell these measures to the Greek coalition party leaders. It is not a foregone conclusion that they will succeed.
But even if the government agrees on the measures, it must next sell them to the troika. Prime Minister Samaras aims to secure a two-year extension for Greece on hitting its fiscal targets. So far, Germany has rejected the idea of an extension on the grounds that if Greece is granted more time, it will need to be granted more funding as well. If the troika does not offer the Greek government any concessions, the Democratic Left and Pasok (the Panhellenic Socialist Movement) could withdraw from government and spark new elections.
If the government manages to find agreement on generating extra savings with the troika, then it still must pass the measures through parliament in September. In fact, to generate extra savings, it appears additional cuts in pensions and wages will be unavoidable. With Greeks back in Athens after their summer holidays and with a high degree of austerity fatigue in Greece, we can expect to see a lot of social unrest in September.
On September 9, the troika will finish carrying out its fifth bailout evaluation of Portugal. There has been widespread acknowledgement among Portuguese government officials that Portugal will be unable to meet its fiscal targets this year, largely owing to revenue slippage. Furthermore, Portugal’s borrowing costs remain extremely elevated. However, Portugal is expected to return to the markets next year.
The IMF will refuse to continue to lend to a country that cannot show it is on a sustainable public debt trajectory for the next 12 months, and consequently the troika and the Portuguese government may begin negotiating an extension of the Portuguese bailout or a second bailout program when the troika’s assessment has been completed in September.
ESM Legality, Dutch Elections and State of the Union
There will be a number of developments in the EZ on September 12. First, the German constitutional court is due to vote on the legality of the ESM. While it seems most likely the court will deem the ESM legal, it will probably also highlight a number of clauses in the ESM that need clarification and tightening. If the German constitutional court did not sign off on the ESM, it would be a major blow to EZ policymakers, who are planning on relying on ESM primary market bond purchases to relieve the current pressure on Spanish and Italian sovereign bond yields.
The Dutch general election will also be held on September 12. Opinion polls suggest that the ruling right-of-center Volkspartij voor Vriheid en Democratie (VVD) will be unable to form a right-of-center majority government and, consequently, coalition negotiations are likely to be protracted. Although the right-wing, Eurosceptic Partij voor de Vrijheid (PVV) has been losing popularity, the left-wing, Eurosceptic Socialistische Partij (SP) may win enough votes to be the second largest party. This would make it more difficult for the new Dutch coalition — whatever its composition — to secure parliamentary support for additional measures pertaining to the peripheral countries.
Finally, European Commission President Jose Manuel Barrosso will deliver a state of the union address on September 12, in which he is expected to unveil plans for how the ECB will oversee banks in the eurozone. Given that many details have not been hammered out yet on how to establish the ECB as the EZ-wide bank supervisor, there is a chance that the progress made on this first step towards a banking union will disappoint.
On September 14-15, European Union finance ministers will hold an Economic and Financial Affairs Council (ECOFIN) meeting in Cyprus. The ESM should be in existence by then, and consequently there is widespread speculation that Spain’s finance minister will negotiate an EFSF/ESM partial bailout program at the ECOFIN meeting. Spain must agree to light conditionality in exchange for the EFSF/ESM purchasing Spanish debt in the primary markets.
The credit ratings agencies S&P and Fitch have recently announced that a request by Spain for EFSF/ESM support would be considered a positive sign. While it is only a question of when and not if Spain asks for official financing, Prime Minister Rajoy seems keen to push it off, saying he needs to know more about the conditions and the ECB’s potential intervention before submitting a formal request. Given the ratings agency announcements and the associated market sentiment, if Spain does not ask for EFSF/ESM support at the ECOFIN meeting, it could spark a sell-off of Spanish debt. Such a sell-off in the Spanish debt market can spill over to the European debt markets and to the global economy.
In the second half of September, the auditors Deloitte, KPMG, PwC and Ernst & Young are due to present their full reports on the capital needs of Spain’s financial sector. The findings will be used to determine the exact amount the Spanish banking sector will need to borrow from the EFSF. EUR100 billion has already been earmarked for the Spanish bank bailout, but many estimates put the cost of Spanish bank recapitalizations even higher.
The French government is to unveil its 2013 budget. in late September. Failure to announce large spending cuts will disappoint the markets, while a willingness to do so risks riling trade unions and stoking civil unrest.
With so many developments in the eurozone in September, will the crisis be solved one way or another by the end of the month? Unfortunately, policymakers must be pushed to the brink in order to make progress, and even then that progress will be slow and incremental. While there is opportunity for policymakers in September to definitively draw a line under the crisis or to see the currency union unravel in a disorderly manner, most likely we will see neither extreme. Instead, eurozone policymakers will probably continue to muddle through for several more months, continuing to address the symptoms of the crisis rather than the root causes.