Collateral Combat and More

Steep stock volatility continued Thursday based on euro-centric developments and a few weak US economic data points.

To start, Greece this week agreed to deposit several hundred million euros in a Finnish state account as collateral for Finland’s portion of the renegotiated bailout. Though these terms were agreed upon July 21, news on Thursday was that Austria, the Netherlands, Slovenia and Slovakia will also make similar collateral demands. Other nations (like Estonia) are objecting to bilateral collateral agreements, calling instead for a euro-wide collateral agreement. These nations are essentially arguing: First, it’s not fair for one country to get collateral and not others. Further, they argue collateral isn’t truly coming from Greece but from other contributors to the bailout. Either way, if Greece is forced to broadly provide collateral, a good portion of bailout funds could be tied up and leave the country less able to service its debts as projected—ultimately threatening the effectiveness of the bailout.

In Italy, the expectation Prime Minister Berlusconi could quickly push austerity through parliament was threatened by a number of new amendments—many from Berlusconi’s own coalition. The proposed amendments include an increase of the VAT, additional pension system reform and a tax on capital previously given amnesty. The austerity measures still seem very likely to pass—but extended debate increases uncertainty and could (further) damage Mr. Berlusconi’s ruling coalition.

Adding to fears, the ECB noted it lent $500 million to an undisclosed bank via US dollar swap lines at an interest rate of 1.1% for a week—this marked the first time the emergency funding facility had been accessed since February 24. The 1.1% interest rate was also above the 80 basis point rate prevalent on foreign exchange markets, leaving some question as to the reason the emergency lines were tapped.

Further, the Federal Reserve released information on an investigation into the solvency of eurozone banks’ US divisions. Fears mounted over discussion of shrinking reserves and speculation foreign banks were pulling capital (provided by the Fed) from their US operations to cover their weak balance sheets in Europe.

That, and some weak US data releases were published Thursday—consumer prices climbed the most in four months, the Philadelphia-Area Manufacturing Index fell to contraction levels and jobless benefits claims ticked up slightly in July.

Not a great news day. Yet, nothing materially new either. With regard to Europe, recent developments follow a predictable pattern we’ve come to expect in the eurozone. Some incremental agreement is made, and then there are objections to it. Ultimately, member nations come back to where they were before—recognizing the need to maintain the euro—it’s two steps forward, 1.75 steps back and has been since 2010. However, it’s important to note eurozone officials are heavily incentivized to act in the best interests of the euro. At the same time, some are also incentivized to initially hem and haw, playing politics to curry domestic voters’ favor, then eventually compromising. The reality is, eurozone politicians can continue to kick the can down the road for quite some time and resolution of peripheral debt woes and the associated competitiveness issues (we’re looking at you, Greece) are unlikely to happen in one fell swoop. That’s not to discount the importance of Europe’s problems—just to say we shouldn’t expect speedy resolution. Eurozone debt issues likely continue to present opportunities for morphing fear and occasionally spiking near-term volatility, at least until a clear plan for long-term maintenance of the EMU is presented.

As for the US data, it’s natural to want all data in an expansion to be uniformly strong. But that’s simply unprecedented. A few weak datapoints do not an impending recession make—anymore than a few strong ones portend surefire ongoing growth. But in our view, taken as a whole, data seem to point to a relative soft patch in overall ongoing growth. This is not an unusual phenomenon—our research shows new expansions commonly decelerate a year or two in before reaccelerating. And that seems to be just where we are.