Policy changes the ECB announced last week will help banks directly and governments indirectly. But the EU fell short on every element of a comprehensive deal. On Friday, investors reacted positively to what was sold to them as a “fiscal compact”. But once the implications of a separate treaty are understood, I fear disillusionment will set in. – Wolfgang Münchau.
And sure enough, that’s precisely what’s happening. Analysts, strategists, and commentators across Europe are asking: ‘Where is the fiscal union?’
That’s because all we got on Friday was the confirmation of measures that had already been announced and, thanks to the “bulldog spirit” of the British prime minister, a weaker legal framework with which to enforce the latest Eurofudge.
Here’s a quick round up, starting with Jacques Cailloux, the chief European economist at RBS
The EU Summit’s decisions will result in some strengthening of the Maastricht framework rather than paving the way to a quantum leap towards political and fiscal union. Indeed, there is no evidence at this stage that EU States are willing to engage in a socialisation of liabilities a key requirement to move towards a fiscal union. While we believe that it is far too early for the latter to happen, market participants and a large number of observers see the fiscal union (and thus Eurobonds) as an exit strategy – in the short term from this crisis. The lack of progress in as far as socialising liabilities is concerned prevents any major involvement of the ECB and or the creation of common bonds in the short term.
The UK veto to a Treaty revision will result in a weakened framework to enforce fiscal discipline. Indeed, this blockage from the UK will result in the creation of an “intergovernmental treaty”. A weaker legal enforcement is clearly sub-optimal as a means of restoring market confidence given the disastrous track record of the SGP. While most EU Heads of States still hope to put this new intergovernmental treaty into the Treaty as quickly as possible, we doubt this will be done any time soon. Markets are thus likely to challenge any framework that relies more heavily on “political commitments” than legally enforceable rules. In a sense, countries will need to behave as if the Treaty had been changed without the strictly binding legal constraints, something reminiscent of the defunct SGP.
Rabobank:
Bunds have opened with a bid tone (yields 2-4bp lower at the time of writing), likely as the market continues to digest the outcome of last week’s EU summit. To us, this summit was not the circuit breaker that had been hoped for. Notably, meanwhile, the Telegraph published an article yesterday citing Bundesbank objections to the summit’s proposal of providing the IMF with bilateral loans so as to afford it greater firepower as it shores up the periphery. Given this was the positive element of the summit, this article may serve to underpin the current risk-off tone.
Morgan Stanley:
Our initial reaction on Friday morning, having waited up all night for the agreement, was to be a bit underwhelmed by the fact that it was not possible to agree on a change in the European Treaty. Having sifted through the post-Summit background material, and having pondered the whole issue some more, we have become a touch more constructive. But we believe that the success of the Summit will crucially depend on the political will to implement the new fiscal compact into an intergovernmental treaty (IGT) and subsequently transpose this IGT into the national legislation and respect the new fiscal rules over the long term – for there was neither a transfer of national sovereignty to the European level on the fiscal policy front nor an enforcement mechanism (over and above the reinforced Stability and Growth Pact, SGP) agreed on at the Summit…
Our concern is that once the immediate pressure from the current sovereign debt crisis starts to abate, it potentially might become more difficult again to fulfill leaders’ long-term ambition of a full Treaty change.
Now, the first real test of Friday’s agreement will come from Standard & Poor’s, which has put Germany and the five other triple-A members of the eurozone on notice for a downgrade. Based on what’s announced, Gary Jenkins at Evolution Securities reckons we will see ratings cut, sooner rather than later:
Looking at the key factors mentioned in the agencies statement it is difficult to see how the sovereigns can avoid downgrades unless S&P wavers and decides now is not the time to make such judgements. High levels of debt, the rising risk of a recession and tightening credit conditions are all still with us after the summit and there was little in the way of real action to deal with any of them. And don’t forget that S&P stated that for the fiscal compact to be credible it would require a pooling of fiscal resources and obligations as well as enhanced budgetary oversight. So all things considered downgrades seem the most likely outcome from this starting point and I would expect them to occur early as this week.
And that’s something to be very, very worried about, reckons Cailloux:
This note pays particular attention to the chain reaction that could follow from a ‘wholesale’ downgrade of euro area members, a scenario which we now believe to be very likely. The ramifications of such a decision by S&P, potentially to be followed in Q1 by Moody’s, would be far reaching with supra national organisations such as the World Bank at risk of downgrades. The downgrade of the EFSF would also be particularly damaging and could affect significantly the ability of this institution to access the market. Should the EFSF struggle to access markets, a negative feedback loop would likely be created with the countries in most need of financial resources likely to suffer most as market participants would start questioning whether their funding needs could continue being met by the EFSF.
Happy new year everyone.
(more to follow)
Update: 10.39am (London time)
We said downgrades looked inevitable but now we’re not so sure.
Via Reuters:
RTRS-S&P ECONOMIST SAYS WANTED TO SEND STRONG SIGNAL EURO ZONE FACING RISK OF MAJOR RECESSION
RTRS-S&P ECONOMIST SAYS WANTED TO SEND SIGNAL EUROPE FACING RISK OF SIGNIFICANT CREDIT CRUNCH
RTRS-S&P ECONOMIST SAYS EURO SUMMIT MADE PROGRESS BUT CAN’T RAISE EXPECTATIONS TOO HIGH, THERE WILL BE MORE SUMMITS
RTRS-S&P ECONOMIST SIX: SUMMIT IMPORTANT STEP FOR POSSIBLE RESOLUTION TO “CRISIS OF CONFIDENCE”
RTRS-S&P ECONOMIST: SUMMIT MADE PROGRESS IN ECB BECOMING LENDER OF LAST RESORT
RTRS-S&P EUROPE ECONOMIST SIX SAYS TIME IS RUNNING OUT, ACTION NEEDED ON FISCAL AND MONETARY SIDE
RTRS-S&P ECONOMIST: THERE’S PROBABLY ANOTHER SHOCK REQUIRED BEFORE EVERYONE IN EUROPE READS FROM SAME PAGE
Is he talking about the same summit as we are? Are we really any closer to the ECB being lender of last resort?
Related links:
S&P plays Grim Reaper for the upcoming death of AAA – FT Alphaville
Is this enough to save the eurozone? – FT Alphaville