Is A Grexit Possible Before The German Elections?

Greek Exit, German Elections
The probability of Grexit has increased due to several factors:

  1. Austerity measures are being implemented, particularly the placement of 25,000 public sector workers into ‘reserve’ (from where they can be fired after 8 months)
  2. The governing centrist coalition has had its majority in the 300-seat parliament reduced from 167 to 155 due to a junior coalition member quitting over austerity measures
  3. Greece has achieved primary surplus, which means that the austerity is enacted purely to pay the official sector cost of interest on loans. However, the probability was low to begin with.

While we do believe that the three factors above have increased it, we are talking a jump from somewhere in the single digits to 10-15%. This is because:

  • Euro area exit is unpopular in Greece. Even the far-left SYRIZA has caught on that Greek voters fear uncertainty and therefore do not want to risk Grexit.
  • Post-German election, an OSI (Official Sector Involvement) is likely, with further cuts in interest rate payments and extension of debt maturity at the very least
  • Greeks have an upper hand in negotiations due to reaching primary surplus, so they will likely eventually receive OSI

An OSI is not an option, and cannot be discussed, in the run-up to the German elections. So it won’t be. However, it is the likely outcome eventually of another Greek showdown. German election is two months away, including August which is usually completely dead in terms of news flow out of Europe. As such, it is highly unlikely that Greece will come up before the election. Particularly not after they already received the funding from the official sector and have passed the necessary legislation. As they fail to deal with implementation of austerity, and further disappointment with privatization, Greece should flare up again as an issue in late-2013. Post-German election, however, Merkel will have the necessary political capital to shove it under the proverbial carpet.

Outlook 2013 With Mr. X: Part Five

BCA Q&AIn this edition of Q & A with BCA, we are pleased to offer a recent question posed by long-time BCA client, Mr. X. Making his first appearance in 1962, Mr. X has visited our offices at the end of each year to discuss the outlook for economic and financial markets.

Please find below the fifth and final installment of a five-part series recapping our December 2012 meeting.

Mr.X I could spend a lot more time questioning you about the outlook, but we probably should start to wrap things up. In our discussions last year, you worked hard to explain why I was too pessimistic about many of my concerns. And here we are again with the same situation – you have a much more positive view than I do about the various problems facing the global economy and markets. Of course, I have to admit that you have been broadly right about the major market trends over the past year. Equities ground their way higher, as you expected, and interest rates stayed low. You told me not to worry about inflation and although I can’t say that I followed your advice, my fears on that issue did prove unjustified. So I am inclined to follow your recommendations and stay invested in equities and spread product for the moment. But I do not expect to feel comfortable about it.

I realize that central bank money printing and zero interest rates will keep markets propped up for perhaps quite a while so it will be a mistake to hide in cash. Yet I fear it will all come crashing down at some point, unless we see a major breakthrough in boosting economic growth and reducing debt levels. I will rely on you to warn me when I should scale back risk in my portfolio.

BCA  We sympathize with your nervousness about the outlook because there continue to be many complex unresolved economic and financial issues. Moreover, how things play out will depend a lot on politics – especially in the U.S. and Europe. That makes things even more unpredictable than usual. We assume that politicians ultimately will behave rationally, but we could be proven wrong on that. If U.S. politicians decide to send the U.S. over the fiscal cliff and/or euro area politicians fail to agree on greater financial and fiscal integration, then risk assets will fare much worse than we have suggested. That is why we advocate a modest rather than aggressive overweight in equities and other risk assets.

As always, we will adjust our strategy during the course of the year as economic, financial and political developments warrant. We will be paying particularly close attention to money and credit indicators to monitor the progress of private sector deleveraging and whether the monetary transmission channels are starting to unclog. At the same time, purchasing managers’ indexes and other measures of business activity and confidence will help signal if animal spirits are returning to the corporate sector. Finally, it will of course be very important to monitor the progress of peripheral euro area countries in implementing structural reforms.

Thanks for following our five part Q&A series with Mr. X!

Implications Of A Tighter Fed

Implications Of A Tighter Fed Q. Some market participants argue that since we are no longer in crisis mode than there is no need for the Fed to maintain such low interest rates. Can you please highlight some of the consequences (both positive and negative) of a tighter Fed?

A. Thanks for your question regarding Fed policy. Our view is that low interest rates are still required – ongoing pressures to deleverage, fiscal restraint, subdued inflation and subpar economic growth all suggest that interest rates will remain low for some time. I am not a fan of QE3 and did write about the various criticisms that can be leveled at this policy. However, I concluded that most of the criticisms had little validity, even though I doubt QE3 has much positive impact on the economy*.

A tightening in Fed policy now would be a mistake unless it was a response to either a breakout in inflation or a much improved economy. Some may argue that higher rates would boost the returns to savers and would signal that the Fed is more optimistic, thus fueling more optimism in the private sector.

Those arguments are not very good reasons to tighten given the weakness of growth.

Best regards,

Martin Barnes
Chief Economist,
BCA Research

*We are pleased to provide access to Martin’s September 26, 2012 Special Report: The Fed’s Big QE Gamble:  Is It A Huge Mistake?

Outlook 2013 With Mr. X: Part Four

BCA Q&AIn this edition of Q & A with BCA, we are pleased to offer a recent question posed by long-time BCA client, Mr. X.  Making his first appearance in 1962, Mr. X has visited our offices at the end of each year to discuss the outlook for economic and financial markets.

Please find below the fourth installment of a five-part series recapping our December 2012 meeting.

Mr.X Commodity prices moved in a broad range over the past year and I suppose this was not a great surprise given the competing forces of hyper-easy money but slow economic growth. Your view of continued easy money and improving growth presumably will be positive for prices in the coming year. Is that correct?

BCA Yes, we do expect a renewed uptrend in economically-sensitive commodities to reassert itself after a rather directionless year. China will be very critical to the outlook because it remains the marginal buyer of many resources. Thus, if our view on China is correct, then commodity prices should move higher. But it will be a moderate increase, not a spike, given the subdued demand outlook in the developed world.

On a positive note, many base metals prices have fallen below their long-term production costs and do not need much demand to appreciate. Oil prices have proved to be very resilient in the face of weak global growth and increased crude production in the U.S. This is consistent with solid underlying fundamentals, and supports a positive view for the coming year. Prices are  no doubt benefiting from a geopolitical risk premium in prices related to ongoing tensions in the Middle East, but the odds are good that this risk premium will persist. Even if political tensions ease, stronger oil demand will be an offsetting force, keeping a floor under prices.

The biggest driver of commodities in the past couple of years has been monetary policy rather than economic growth. This shows up the outperformance of gold over metals. However, the ratio of gold to metals looks as if it is breaking down, pointing to a looming change in the underlying environment.

Stay tuned for more on this five part Q&A series with Mr. X!


Outlook 2013 With Mr. X: Part Three

Macro Research | BCA | Independent Economic ResearchIn this edition of Q & A with BCA, we are pleased to offer a recent question posed by long-time BCA client, Mr. X.  Making his first appearance in 1962, Mr. X has visited our offices at the end of each year to discuss the outlook for economic and financial markets.

Please find below the third installment of a five-part series recapping our December 2012 meeting.

Mr.X With regard to the U.S. economy, I read a lot of reports about an upturn in housing as a reason to be optimistic about growth over the coming year or two. How important do you think housing will be? Also, what else might contribute to a better year ahead for the economy?

BCA Housing has already started to make a positive contribution to growth for the first year since 2005. Increased residential investment accounted for 16% of the growth in real GDP in the first three quarters of 2012. Meanwhile, the inventory of unsold new houses is at a historic low, and prices have clearly bottomed in the major cities. So in that sense, the picture definitely has improved. At the same time, it is going to be a long road back to normality.

There is still a large overhang of vacant properties that will act as a depressant and this will clear only gradually. Much of the activity in the resale market reflects buying by investors, speculators and overseas residents.The mortgage application purchase index has barely recovered from its lows, reflecting the fact that many would-be buyers do not have the downpayment or good credit score now necessary to qualify for a mortgage loan. The bottom line is that housing will be a positive source of growth in the next several years, but a modest one.

Fortunately, other areas of the economy also are improving. For example, the drag from state and local government cutbacks is moderating as tax revenues revive. State and local government employment has stabilized after its earlier steep contraction.

Finally, the corporate sector should become more comfortable increasing spending and hiring once the fiscal cliff issue fades. Private sector employment is growing, but only at a modest pace. Similarly, capital spending, although moving up, has not been as strong as one might have expected given the strength in profits and the need to sustain productivity. There is lots of scope for improvement.

As we noted earlier, fiscal drag will keep growth near 2% in calendar 2013. However, growth should climb back to around a 3% pace in the second half and in 2014, barring any new shocks. (tweet this!)

Stay tuned for more on this five part Q&A series with Mr. X!