Europe Moves, Market Yawns

The market seems largely unimpressed with the European finance minister’s decision yesterday to formally initiate the special purpose vehicle that will sell bonds backed by guarantees from euro zone countries and then uses those funds to make loans to members in need.

The bonds will be sold only if/when aid is requested. The European Financial Stability Facility is initially projected to be a 3-year project. The guarantees will be for 120% of each country’s pro-rata share and this is seen as helping ensure that the bonds will be rated triple-A and would be acceptable as collateral for ECB operations. Many observers are skeptical that new debt can really be an effective remedy for countries that have too much debt.

Another important agreement that Finance Ministers reached was that budget drafts would be examined by the EU and other countries each spring, with sanctions to kicking in faster for violations. While this seems to be a step in the direction of greater fiscal coordination and discipline, many fear that the political will may not last much beyond the crisis itself. Previous efforts to enforce the Stability and Growth Pact were diluted by Germany and France a few years ago.

The ECB still does not directly acknowledged the amount of member bonds it is buying or the composition. The market is backing into estimates by watching the size of the operations meant to neutralize the impact of said purchases on money supply, which incidentally continues to contract. The ECB invited bid on terms deposits for 40.5 bln euros. That means that each week ahs seen the ECB buy few bonds. In the first week of its operation the ECB bought 16.5 bln euros. In the second week, 10 bln euros were purchases. In week three, 8.5 bln and week four 5.5 bln of peripheral European bonds were bought. This may have stabilized Greek bonds, where reports suggest the buying has been concentrated, but as we have noted the spreads in the core are also now widening.

Note that the Netherlands and Belgium hold national elections this week (June 9 and June 13th respectively). In the former, the Liberals, who promise more spending cuts, look to be ahead in the polls. In Belgium, which has among the highest debt to GDP ratios in the euro zone, the Flemish Nationalists appear poised to become the largest party. The political consequences could be serious as it favors a more formal split with the poorer, French-speaking region in Wallonia.

Japan’s new Prime Minister has wasted little time in putting a new cabinet in place. Two appointments are important for investors. First, the former deputy finance minister Noda will replace Kan, the new PM at the helm of the finance ministry. Like Kan, Noda is perceived to be a fiscal hawk. He opposed, for example, bond issuance to pay for new spending. A key issue is the retail sales tax. PM Kan supports an increase as part of larger fiscal reform. Noda’s views do not appear to have been drawn out yet, but he will likely support it as well.

Second, Kan appointed Yukio Edano as the number two in the ruling DPJ. This is important because Edano was a critic of the Ozawa and had urged him to resign earlier this year. This helps distance the new DPJ government from the Ozawa era and this in turn may bolster the party’s support ahead of next month’s upper house election. Meanwhile, Ozawa is reportedly contemplating forming a new party.

The euro has fallen to new record lows against the Swiss franc. The SNB has been silent and if it is intervening it is doing so very quietly and without much impact. Today the SNB reported that its holdings of foreign currencies jumped by almost CHF79 bln to CHF232.4 bln from April’s 153.6 bln. Stops and/or optionality struck near CHF1.3850 gave way and the euro tumbled to CHF1.3785. Swiss reserves have increased markedly and are approaching Asian and Middle East levels. SNB efforts are can only be understood now as smoothing operation rather than defending certain levels as it may have in the recent past, like CHF1.50 or CHF1.40.