Daily Macro Note

Spanish Bank Plan? No idea.

The ECB said yesterday that it has not been consulted, nor has it expressed an opinion, on Spain’s bank-recapitalisation plan. They day before, it was reported that the ECB had rejected the idea. I have no idea what is going on here.

Incidentally, Michael Pettis makes an interesting point about the market’s assessment of the risk of, and arising from, Spanish exit fro the Eurozone. This danger is calculated as:

risk = ‘probability of exit’ x ‘cost of exit’

Early in the Euro crisis, the cost of exit to Spain is relatively small (because it has not yet built up large TARGET2 liabilities), which makes the probability on the high side (because government knows that the cost of exit is small). As the cost of exit increases (with rising TARGET2 liabilities), the probability of exit falls and the risk decreases. However, as TARGET2 liabilities become very large, the increasing cost of exit overwhelms the falling probability of exit, and risk starts to rise again. More here: http://on.ft.com/KDelfc. This is an interesting idea, but I am not sure that it captures the essential point. I do not think markets understand, or at least are mainly worried about, TARGET2 liabilities; I think they are much more concerned about the massive economic disruption that a euro exit would cause in Spain. Thus I think that the rising probability of exit, not the rising cost, is the salient feature of the present situation.

Fed Governors Appointed!

After six years short of its full complement, the Federal Reserve Board has seen its two empty spaces filled — by one Democrat and one Republican. This seems to have been the way that America’s senators overcame their tragi-comic obstructionism (the fault lying much more on the Republican side). Jeremy Stein and Jerome Powell will be at the next meeting of the FOMC and, as Fed governors, are likely to vote with the Chairman (giving him seven out of twelve votes). However, Elizabeth Duke is already due to retire, and has only stayed on because of the empty seats — so there could well be another one soon.

German Constitutional Court

Quentin Peel makes a good point in the FT: the German constitutional court might well rule against Eurozone bonds unless there was a credible framework to control countries’ spending at the European level. Otherwise, the German government would be making an open-ended commitment to support other countries — which it is constitutionally barred from doing.

I have not based any of my recent arguments on the imminent arrival Eurozone bonds — in fact, I have rather tended to ignore the question. I think the degree of fiscal integration that they entail is some way away, and that Merkel does have a point that the institutional arrangements would have to be worked out in detail before such bonds could be issued. This is a long process. On the other hand, I would not argue that they will never come: the SPD is in favour, and even if Peel is right about the German constitution, constitutions can be changed.

Why not a clearing house?

In the normal run of things, central banks lend to banks in a crisis, and then the crisis passes. The crisis in the Eurozone at present is different: it is caused, fundamentally, by balance-of-payments imbalances which the ECB is now funding. This process could go on indefinitely, with its logical conclusion being that the ECB would be responsible for all of the funding needs of peripheral banking systems. One assumes that this would be a problem. But is it? Why should the ECB not become, effectively, a clearing house for all international interbank lending within the Eurozone? In other words, if interbank lending were completely withdrawn from Spain, and Spanish banks lost all their deposits, why should the ECB not replace them in their entirety, lending freely to those who ask? True, banks would be able to borrow as much as they wanted; but that was pretty-much the case before the financial crisis. At least if they were borrowing from the ECB, its collateral standards would keep them out of excessively risky activities.

One problem with this idea is the shortage of collateral, which in Europe is particularly acute. The ECB does not rehypothecate the collateral it receives — it just locks it up. This breaks the collateral chains that underpin the secured lending markets and significantly reduces the amount of secured lending that can take place. Andrew Hunt argues that there are steps the authorities could take to deal with this problem (as it exits today), such as moving the ECB to unsecured lending, but that they are unlikely to be taken except in a serious crisis. If they are taken, however, that takes me back to a modified version of my original question: what would be the problem with the ECB becoming central clearing counterparty for unsecured interbank lending within the Eurozone?


  • US Case-Shiller -2.6% YOY a.e. Mar.
  • US CB consumer confidence 64.9 d.e. and fell. This contrasts with Michigan sentiment, which hit a new post-crisis high last week.
  • Japan PMI 50.7
  • Australia retail sales -0.2% d.e. This raised expectations for further rate cuts.
  • US pending home sales -5.5% d.e. Apr.
  • Australia private capital expenditure 6.1% QOQ b.e. Q1.
  • Australia private sector credit 0.4% b.e. Apr. Remains fairly strong for the post-crisis period.
  • Japan average cash earnings 0.8% YOY d.e. and fell, Apr.
  • Swiss GDP 0.7% QOQ Q1 b.e.
  • German retail sales 0.6% b.e. and fell, Apr.
  • German unemployment change 0, d.e., Apr.
  • Eurozone flash CPI 2.4% d.e. and fell, May.
  • US ADP payrolls 133k d.e. but rose, May.
  • US Prelim GDP 1.9%, revised down from the advance estimate of 2.2% on lower inventory and government growth. Consumer spending was also revised down, as was income (which depressed the saving rate to 3.6%).
  • US Initial claims 383k d.e. and rose.
  • Australia manufacturing index 42.4, fell.
  • Japan capital spending 3.3% QOY, b.e.
  • China PMI 50.4, d.e. and fell.
  • HSBC China PMI 48.4, revised down from flash estimate.
  • Swiss PMI 45.4, d.e. and fell.
  • Italian PMI 44.8, b.e. and rose.
  • Eurozone final PMI 45.1, revised up a little from flash estimate.
  • UK PMI 45.9, d.e. and fell sharply.
  • Eurozone unemployment held steady at 11%, a.e., Apr.

Coming Up

  • US non-farm payrolls
  • US personal income and outlays report