Tsipras makes Merkel an offer she can't refuse

How should we interpret this week’s volte-face by Tsipras and the Syriza government in approving austerity concessions to the Troika that had been specifically rejected by Greek voters in a referendum less than a week before? Short term, this would seem to provide an opportunity for celebration for creditors and financial markets in that the Greeks will have to repay all their debts and perhaps more importantly will not offer a precedent to other indebted nations to demand debt relief and therefore open the floodgates to unlimited QE and debt monetisation so feared by the northern block.

This reprieve however would be both temporary and illusory as it fails to address the political or economic reality of the situation. The most obvious of these is that Greece is bust and chasing it into the grave for the last sou will make it less, rather than more likely to be able to pay what it owes, let alone become a functioning and contributing member of the EU. Politically, it is also counter-productive for the EU to be shown as a rapacious creditor in league with a politicised and conflicted ECB to use weapons of mass financial destruction to terrorise the Greeks into submission. Without a debt relief, how long do you think Tsipras and his Syriza party will last and if not them who – Golden Dawn or some other extreme fringe, and then what?

At face value, the concessions approved last night by the Greek legislature is at best another attempt to kick the can down the road. While agreeing to cut government expenditures, including pensions and defence along with improving tax collection rates are fairly uncontentious, the current plans also include a number of counter-productive proposals including heavy increases in consumption taxes (eg 23% VAT on restaurants and increased ‘luxury’ taxes on recreational boats on anything longer than a dinghy) as well as increases in corporate and tonnage taxes along with the removal of Island tax breaks. How this is expected to get more tourists to want to go on holiday to Greece or more ships to locate there is a mystery to me and seems to be blind to the simple fact that these industries are mobile and will just go elsewhere and thus further compound the revenue erosion. Does anyone in their right mind actually believe the current commitment to stick to a primary surplus target of 1% for this year rising to over 3% from 2017 is achievable? Look at some of the other proposals and things get even more ominous. Consider the proposed amendments on insolvency laws to get debtors to pay up loans or ‘consultants’ on how to deal with bad loans or the opening up of restricted professions such as court bailiffs. Throw in the asset privatisations of the electricity grid company, regional airports and shipping ports and the Greeks will be little more than rayahs in their own land. https://www.youtube.com/watch?v=rRBPS3o_IvU . Germany may be obsessed with its hyper-inflation history, but it seems to have also forgotten the dangers of leaving a nation without hope or self-respect.

The problem with the above scenario however, is that it doesn’t explain why Tsipras would commit political suicide agreeing to concessions that would not work anyway. It also fails to recognise the wider geopolitical issues at stake which need Greece to stay in the western sphere of influence and would happily sacrifice Germany’s aversion to sovereign debt monetisation to achieve it. Greece has long existed on a number of fault lines (geological, ethnic, cultural, political and religious) and this has been reflected in its complex politics. Add in gas politics of Gazprom cancelling South Stream in favour or a new route through Turkey and Greece and the EU’s domestic spat over debt relief has acquired a more serious geo-political dimension. Tsipras has obviously been playing this card with his meeting with fellow orthodox Putin and the US are concerned enough to put pressure on Europe.


The US therefore needs a deal to keep Greece inside the tent, but knows that Germany is resistant to debt monetisation. As befitting the EU and in the best tradition of the Godfather, they need an ally on the inside that can propose the deal to both parties while furthering its own interests http://youtu.be/fuWkcKbBQkg and this is where the French come in. At the last moment, the French have sponsored the Tsipras’s apparently generous concessions which will form the basis of discussions at tomorrow’s broader EU meetings. Debt relief is not explicitly included, but the IMF ‘leak’ that Greece debt is unsustainable and needs restructuring (ie relief) was incidentally released and not accidently. Tsipras must know that his concessions in isolation would destroy Syriza and resolve nothing, so his participation must therefore have included broader assurances also on debt relief. Germany no doubt suspects that its red line on sovereign debt monetisation may be assassinated at this meeting arranged by its ally and hence some of the rumoured hostility to the plan even though at face value Tsipra has conceded on virtually everything barring a tribute of children. In many ways, Merkel is being manoeuvred into an impossible position. Reject IMF evidence of the need for debt relief and drive Greece into default and her dream of European unity starts to look pretty shabby. Agree to it however, and a principal will have been conceded which will inevitably turn the Eurozone into a transfer union, but without political responsibility or restraint which may hasten calls for a northern block.

Greek referendum - all part of the Varoufakis game

Greece votes a resounding 61% “No” to the Troika debt proposals, yet financial markets remain largely unfazed, with European equity markets declining initially by less than 2% and 10 year bond yields for Italy, Spain and Portugal harden by less than 10bps. With traders having been weaned on a succession of last minute resolutions to avert a crisis (US sub-prime, US debt caps, PIIG’s, to name a few) markets seem to be clutching at the conciliatory comments by Alexis Tsipras and resignation of Yanis Varoufakis together with Angela Merkel’s comments that the Greeks’ decision must “be respected”, whatever that is supposed to mean. But is this a move towards conciliation that is being assumed by markets or an attempt by wily politicians to distance themselves from the impending train-wreck? Should one follow the market conditioning of the past five years and ‘buy the dip’ (http://www.youtube.com/watch?v=0akBdQa55b4) or take note of that the economists at both JP Morgan and Barclays working models now assumes ‘Grexit’?

It is looking increasingly obvious that the Troika negotiations have been set up to fail. Greece is bust and has been for years. EU bureaucrats want to hide it, but Tsipras knows this, so does Merkel, the IMF and even my mother. Another so called bailout that merely adds more debt to pay the interest back to the bankers on the last lot and keep the Greek people in debt bondage for another two generations is now no longer a politically viable option. The terms of that last bailout, which saw over 90% of the €240bn package go back to financial institutions rather than the Greeks, has done the Troika no favours in selling its latest ‘deal’. Politically, Merkel cannot concede the principal of debt forgiveness to Greece given the long line of other EU petitioners who will demand the same, particularly now that the ECB has ECJ clearance for QE. Tsipras however can demand now less given his original election mandate and now the referendum. The referendum was less about giving him better legitimacy to negotiate a better deal from Merkel, but a mandate to reject the Troika. Up until a couple of weeks ago, markets were expecting Tsipras to submit to theTroika’s proposals notwithstanding his election mandate. Now, the mandate is explicit in that he is unable to concede. Burning ones ships to ensure no turning back, may not have been an Athenian tactic, but they seem to have learnt from Cortes. With suitable goading from his finance minister and game theoretician, Yanis Varoufakis, the Troika have adopted a hard line in negotiations and a proposal that Tsipras could take back to Athens to get squashed, but from which it will be nigh impossible for either side to substantively retreat from. Varoufakis’s resignation at his moment of victory therefore is not about securing concessions that cannot be made, but to remove himself as factor from the inevitable collapse in negotiations. This has been set up not just to fail, but to leave the Troika taking most of the responsibility for it.

Over the next few days, markets will urge investors to buy the dip, but may have a rude awakening. Some ‘leading’ investment houses were even recommending investors rotate into financials last week and ahead of the referendum, no doubt hoping for a ‘Yes’ vote and citing that the ECB has now relieved most of the banks of their direct Greek bond exposure, although not the unknown derivative tail risk. We are not aware of whether their recommendation has now been revised following the result or whether they are compounding the error by attempting to brazen out the newsflow with hopes that a last minute debt resolution. Either way, these remain dangerous waters to be exposed to financials, particularly amongst the EU peripherals. The first test meanwhile may come as early as next week when a small Japanese (Samurai) bond of approx Yen 20bn matures. Will this be the first credit event and domino?

Markets find it tough to break the BTFD conditioning

Was the Friday rebound in equity markets another BTFD opportunity, or a possible suckers rally? Certainly, the wall of central bank liquidity over the past five years have reduced the market’s pricing mechanism to little more than a pavlovian response to the next turn of the central tap and where bad news can be good news for prices if it raises expectations of a bigger flow.  News however, whether good or bad that does stimulate more liquidity may just be bad news.  

Last week had a lot of ‘bad’ news. This however was not new bad news. The US continues to goad Russia, albeit now through bombing its ally Syria and getting its own ally Saudi Arabia to cut oil prices on which Russia also depends. Ebola continues to spread, which is bad for airlines, but good for pharma and security. Japan continues to struggle with radiation, a collapsing economy, rising real inflation and what should be an utterly discredited and failed QE policy.  Europe meanwhile continues to grind back into recession, but having approached the moment of truth may be shying away from the full QE programme that advocates were predicting after Draghi’s recent Jackson Hole speech.  Notwithstanding a partial attempt with an ABS programme, this fell short of expectations and so bad news was just bad news and markets reacted accordingly.

Unfortunately, market volatility is an inevitable consequence of the deliberate confusion about the nature of the ECB and Euro that has been sponsored by politicians and central bankers. At the centre of this has been Merkel who has been trying to ‘hunt with the hounds and run with the hares’.  EC treaties are clear and indeed have been paid lip service to by Draghi when he re-iterates that the EC is “not a transfer union”.  His actions however belie this, including advancing ECB liquidity to domestic banks who have used this to buy local sovereign debt in the secondary market to circumvent the ECB’s prohibition to fund primary debt. Notwithstanding the German constitutional court’s ruling in February (which had been sat on for around 9 months) that the ECB’s OMT plan “manifestly violates” the EU treaties, Merkel seems happy just to turn a blind eye while playing a ‘good cop, bad cop’ game with Bundesbank president Jens Weidmann.  This, together with Draghi’s “whatever it takes” and subsequent utterances have goosed the market into believing peripheral EU sovereign debt is now backstopped by the ECB and therefore German tax-payers. German tax-payers however have not been consulted and seem to be in no mood to comply, as today’s comments from a key Merkel ally, Hans Michelbach of the Christian Social Union (CSU) might suggest. Not only is Draghi accused of “endangering the stability of financial markets”, but more pertinently Herr Michelbach reminds us of the now largely ignored constitutional court ruling and that “The ECB needs to change its policies so that they come back within the terms of the treaties”

http://uk.reuters.com/article/2014/10/04/germany-ecb-draghi-idUKL6N0RZ07N20141004

So bad news in Europe may not be the ‘good’ bad news that markets have run with during the US QE programme, but ‘bad’ bad news for markets if the ECB is approaching that crisis point where it has to reveal whether it has any real bullets in its monetary pistol or has just been fooling us with blanks. Perhaps by taking Europe to the cliff, Draghi feels he can present the German tax-payers with a fait-accomplie from which they dare not refuse, as such a refusal would have devastating consequences to peripheral bond markets and banks. Germany’s decision however, will not be telegraphed to us muppets ahead of time. With peripheral Euros now invested back into peripheral bonds and banks, the creation of a hard currency Northern block at this stage would not be saddled with a mountain of peripheral euros in Germany which might have to be converted at par into the new Deutschmark. While the ‘soft’ Euro areas would then be free to monetise debt and devalue, yields would rise significantly and there would be no shortage of burnt positions amongst bond investors.

So what was the cause of Friday’s market euphoria, a cure for Ebola, peace on Earth? No, it seems a slightly better than expected monthly job growth figure in the US non-farm statistics for September.  To qualify as a ‘good’ figure for markets however would either be a really ‘bad’ number that would raise the prospect that Yellen would defer the QE tapering and keep the liquidity tap and low rate environment going indefinitely or a figure that was so good as to signal a serious acceleration in US GDP growth prospects. Unfortunately neither of these would apply to the September numbers. At +248k net new jobs (+236k private), US job growth was around +30k ahead of consensus and the trailing 12 month rolling average of approx. +213k, albeit in large part reflecting a +40k MoM swing in retail (from -4.7k in August to +35.3k in Sept).  While the numbers are ‘so..so’, they do not deserve the praise heaped on them by political spin doctors who focussed on the flawed unemployment ratio (-0.2ppts to 5.9%). 

Perhaps a little perspective is needed for this political hot potato. First, the context. For the year to end September, US private sector employment increased by +2,588k/+2.25% to 117.524m versus a total civil non-institutional population that increased by +2,278k/+0.93% to 248.446m.  This is hardly spectacular given the government and central bank largesse over the period with private sector job growth only just exceeding population growth. But what about incomes?  Average hours have barely changed at 34.6 pw (vs 34.5 pw) while average hourly earnings are struggling to keep pace with inflation with a +2.0% YoY increase to $24.53 p hr (from $24.04 p hr) to take average weekly earnings from $830.07 pw to $848.74 pw, an increase of +2.2% YoY.  Multiply this by the increase in employment and this implies that private sector wages increased by +4.6%/+$225.8bn to approx. $5.2tn. Although this may seem ok, there are a couple of points one may need to consider. Firstly, don’t forget that the private sector ultimately has to support the entire working population and that these figures are nominal. Also, remember that the US economy is worth approx. $17bn pa, which means that the $225.8bn increase in private sector wages is equivalent to only +1.3% of GDP.  If consumption accounts for around two thirds of GDP in the US, clearly private sector wage growth alone will not be offering much of a boost this year!

So back to Friday’s market bounce. As the dog might utter, “Woof, Woof”