Now What?

By Marc Chandler

As had been anticipated, the Greek parliament has approved the austerity measures along party lines. That it had been anticipated in the currency market is evident in the euro’s appreciation in recent days from almost $1.41 on Monday to almost $1.4450 today. The peripheral bonds have also rallied over the past 336 hours. As we have warned, the euro is vulnerable to a "buy the rumor sell the fact type of activity. Support for the euro is seen in the $1.4340-50 area now.

The parliament will vote on the implementation bill tomorrow. This may be a bit stickier, but it too is likely to pass. Assuming so, attention will turn again to Greece’s second aid package. There are a number of plans being discussed, and although the French plan may form the basis of discussion or the terms of the debate, it is not clear that those details will carry the day. In particular, any kind of guarantee using EFSF does not seem to sit well with the ECB. The 30-year extensions do not sit well with many banks. The roll-over itself has been cautioned against by Fitch.

Today’s vote keeps the situation from falling into the abyss, but it is not clear how far from it the situation remains. The failure of the opposition to support the measures is problematic. The Socialists have begun lagging in the polls and if the government were to collapse, all bets would be off.

In addition, while the markets have been focused on Greece, there has been a marked deterioration of the situation elsewhere, though the relief rally in the peripheral markets is masking this.

First, note that Portugal’s Q1 budget deficit came in at 8.7% of GDP. This year’s target is 5.9% (2010=9.2%). New austerity measures will likely be forthcoming shortly. Recall that the old government collapsed when the opposition balked at the extreme austerity. The EU/IMF softened the terms under the aid package, but the new government now has to dust off those proposals that it had previously blocked. This is a subtle example of the political instability that the IMF/EU plan seems to generate.

Second, political problems are coming to the fore in Spain. The minority Socialist government (seven seats shy) will need opposition support for next year’s budget. The Catalan Party yesterday indicated it will not support the government’s budget. Neither will the main opposition party. The budget will not come up for a parliamentary vote until September. Even through Spanish law allows for a reversion to the previous year’s budget, tradition requires an election. The risk is that Prime Minister Zapatero does not complete his term that expires March 2012.

Moody’s has expressed concern about the regional fiscal slippage. The regions account for 1/3 of the government spending and half of the public sector workers. Total debt regional debt was 11.4% of GDP in Q1 11 up from 10.8% in Q4 10. Austerity measures are not being shared equitably between the central government and the regions. The central bank warned a couple weeks ago that regional finances are worsening. Despite the passage of some labor reforms, the IMF has has urged Spain to accelerate its efforts to overhaul the economy.

Third, Italy is likely to announce additional austerity measures as early as tomorrow. S&P warned in May and Moody’s in June about the outlook for Italy’s credit worthiness. Prime Minister Berlusconi has had a number of setbacks at the hands of the public this year already, but his most pressing challenge is within his government. Coalition partner Northern League may not support the 2012 budget and appears to have increased pressure on Finance Minister Tremonti to resign. The 10-year BTP-Bund spread was at EMU highs prior to the Greek-inspired relief.

Recent ECB comments, including yesterday by Trichet, underscore that the ECB is still on course to hike rates next week. The recent string of US economic data has been relatively soft and there is some downside risks to next week’s US employment data (ADP and NFP). This analysis suggests that if you "buy the rumor, sell the fact" on the Greek vote, there may be a better opportunity to be long euros by early-mid next week. However, over the slightly longer-term, the European debt crisis is far from resolved and the problems in Spain and Italy need to be monitored closely.