Decision Time for
the Euro zone
Jan von Gerich
12/6/2012
Markets
Also longer German bond yields following in the
footsteps of Japan
2
The Euro zone will survive, but notable bumps still
ahead
•
A Greek Euro-exit threatening to push the
Euro-zone into a deeper recession
– The recent development of leading indicators
worrying
•
•
Spain will need external help with its bank
Bonds to remain well supported in the near
future
– With short rates zero or negative in many
cases, longer bonds still with pick-up
– Stay within the core countries for now
•
More determination needed to build a longerterm future for the euro
– Euro-zone governments need to pave the way
for a tighter monetary union
– In the end, the ECB will do what is needed to
save the euro
– Pressure to let inflation accelerate
– Risk of an uncontrolled chain of events not
zero, although still small
3
The recent falls in Euro-zone confidence numbers
worrying
Source: Reuters EcoWin
4
Weak loan demand point to a weakening economy in
the near term
5
The biggest drag from fiscal consolidation this year
Note: European Commission Spring 2012 Economic Forecasts
6
US banking system looking much healthier compared to
Europe
7
Many banks very reliant on ECB funding
8
Also progress seen, but still a long road ahead
• Ireland in external balance already,
while also Spain come a long way
9
• Restoring competitiveness will take
years
A Greek exit threatening to escalate the debt crisis once
again
10
Bank run in Spain much more difficult to handle than
one in Greece
2000
1750
Deposits excluding monetary
financial institutions and the central
government, EUR bn
1500
1250
1000
750
500
250
0
Jan-99
May-01
Oct-03
Greece
Source: the ECB
11
Mar-06
Spain
Aug-08
Italy
Dec-10
Deposit outflows so far been relatively limited
y/y change in bank deposits excluding
monetary financial institutions and the
central government
10%
5%
0%
-5%
-10%
-15%
Source: the ECB
12
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Fr
a
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al
et
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G
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m
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m
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y
Ir
el
an
d
iu
el
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B
Eu
r
o
zo
ne
-20%
LTRO support already behind for Spanish and Italian
government bonds
450
Government bond holdings of
banks, EUR bn
400
350
300
250
200
150
100
50
0
Jan-99
Sep-01
Jun-04
Germany
Source: the ECB
13
Mar-07
Italy
Dec-09
Spain
Central bank system financed the capital flight from
Spain
14
In Spain the housing market remains a big source of
uncertainty
15
Spanish construction sector a drag for the economy for
a long time
16
The gap between public expenditure and income still
great
17
Weak structural growth a problem for Italy
18
Economic growth an important variable in debt
sustainability
260%
Development of debt to GDP with
starting debt of 100% of GDP and 3%
public sector deficit
240%
220%
Debt / GDP
200%
180%
160%
140%
120%
100%
80%
60%
0
10
20
30
40
Time / years
4% nominal economic growth
No nominal economic growth
19
2% nominal economic growth
50
The weakening Italian economy to receive added
attention again
20
Italy learned to live with a high debt
21
Flattening Spanish and Italian curves implying
increasing near-term worries
22
The number of core countries fallen
23
Belgian and Irish bonds provided the best YTD return
this year
10%
iBoxx government bond index year-todate total returns by country
8%
6%
4%
2%
0%
-2%
-4%
Source: iBoxx bond indices, Reuters EcoWin
24
iu
m
B
el
g
n
pa
i
S
an
d
Ir
el
It
al
y
ne
Eu
ro
zo
nc
e
Fr
a
rla
nd
s
ria
N
et
he
A
us
t
y
er
m
an
G
Fi
nl
an
d
-6%
Euro-zone not with huge problems on an aggregate
basis
10
8
6
4
2
0
-2
-4
-6
-8
-10
Public balance, 2012, %of GDP,
Primary balance, 2012, %of GDP
Current accout balance, 2012, %of GDP
Source: European Commission Spring 2012 Economic Forecasts
25
om
A
gd
U
S
Ki
n
te
d
U
ni
It
N
al
et
y
he
rla
nd
s
A
us
tr
ia
Po
rt
ug
al
Fi
nl
an
Eu
d
ro
ar
ea
G
B
el
g
iu
m
er
m
an
y
Ir
el
an
d
G
re
ec
e
S
pa
in
Fr
an
ce
-12
The recent weakening in the euro only in line with the
development of interest rate differentials
26
How can the debt crisis end?
•
The ECB/EFSF buys bonds as needed, increased IMF/EFSF/ESM resources try to provide a
sufficient backstop
–
–
–
–
•
Economic growth (and structural measures) given higher priority
–
–
–
–
•
More time to implement austerity measures
Moving towards euro bonds, banking and a political union
The ECB a permanent lender of last resort for governments
Higher inflation part of the solution
Managed debt restructuring on a wide scale
–
•
Euro zone countries continue austerity measures and structural reforms
Economic growth weak for a long time
Gradually closer co-operation between the members
An individual member may decide to leave the Euro zone
Very challenging to implement without breaking the
Euro zone
Break-up of the Euro zone
–
–
–
–
Individual currencies make a comeback
Several Euro zone countries default on their debt or re-denominate in a new currency
Financial crisis II
The real safe havens in non-EUR investments
27
Notable risk of higher inflation ahead not being priced
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
Jan-05
May-06
Sep-07
Feb-09
Jun-10
Nov-11
5-year inflation starting in 5 years' time as implied by EUR inflation swaps
5-year inflation starting in 5 years' time as implied by USD inflation swaps
Sources: Reuters, Nordea
28
The Euro zone will survive, but notable bumps still
ahead
•
A Greek Euro-exit threatening to push the
Euro-zone into a deeper recession
– The recent development of leading indicators
worrying
•
•
Spain will need external help with its bank
Bonds to remain well supported in the near
future
– With short rates zero or negative in many
cases, longer bonds still with pick-up
– Stay within the core countries for now
•
More determination needed to build a longerterm future for the euro
– Euro-zone governments need to pave the way
for a tighter monetary union
– In the end, the ECB will do what is needed to
save the euro
– Pressure to let inflation accelerate
– Risk of an uncontrolled chain of events not
zero, although still small
29
No quick solutions to debt problems in store…
30
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31
Thank you!
Jan von Gerich
Chief Strategist, Developed markets
Global Research
+358 9 165 59937
jan.vongerich@nordea.com