Saturday, 14 January 2012
Print Futuristic Outlook for 2012: The Escalating Debt Crisis, the Worst yet To Come
Focusing On the Major Events in 2011: As 2011 has come to an end Europe continued to suffer from the escalating debt crisis, where European leaders, despite the huge effort made in the past year, failed to control the debt crisis and prevent the contagion from spreading into larger economies, and accordingly the sentiment deteriorated further and the confidence remained fragile. All eyes will be focused on 2012, tracking the implementation of the measures taken in 2011 to heal the debt crisis, especially after the crisis forced growth to slow significantly, the pace of recovery to falter and the euro zone to slip back into a “mild” recession, which eventually threatens the entire monetary union that is currently at risk. In 2011 Greece, Ireland and Portugal were on bailouts, where rising yields on their bonds led those countries to seek financial aid from the European Union and the International Monetary Fund. Portugal and Ireland were able to start to manage with the financial aid provided and signs of progress; however, as the wheel of time kept on turning for Greece that needed another bailout, which also was approved by the European Union and the International Monetary Fund after Papandreou’s government stepped down for Lucas Papademos, the former European Central Bank Vice President took charge with main objectives of obtaining the sixth tranche of 2010’s bailout package in addition to the second aid package, noting that Greece could go through bankruptcy as soon as January without any financial aid. Throughout the past year, we saw Italy and Spain following Greece, Ireland and Portugal’s steps into deep crisis, where despite the strength of these economies, Spain was affected sharply by the escalating debt crisis and weakening global demand, where Spain is suffering from the highest unemployment rate in the euro zone which is currently standing at 20.3%. For Italy, yields on the nation’s securities surged sharply to records after European leaders failed to create a firewall around indebted nations to prevent the debt crisis from threatening the euro-zone third largest economy, which in result led investors to weigh the failure of such large economies and speculate that Italy and Spain will be the next victims of the crisis. In the fourth quarter of 2011, political changes took place in the euro zone, where the Italian Prime Minister, Silvio Berlusconi stepped down, while Mario Monti, the former European Commissioner, took the lead and announced a new technocrat government and accelerated the implementation of austerity after he pledged to lower the current debt-to-GDP ratio of 120%. After the political changes seen in Italy, Spain and Greece the European Summit came to add more concerns to the market after European leaders ruled out the European Central Bank intervention in fighting back the crisis, which didn’t meet market speculation and spread pessimism across the board, as investors saw that the European Central Bank should play a larger role in tackling the crisis. European leaders also agreed in the last summit during 2011 to maximize the contribution of the International Monetary Fund in tackling the debt crisis, where European nations will provide around 200 billion euros to the facility, which in turn will run alongside with the European rescue fund in providing bailouts for European indebted-nations. The summit deal also provided details regarding the European Financial Stability Facility and the European Stability Mechanism, where leaders decided that the temporal facility (EFSF) should continue functioning in 2012 and will run side by side with the permanent facility (ESM) that will be launched in July, where both facilities in addition to the International Monetary Fund will create the so-called “Bazooka”, which is expected to provide further support to European nations to end the two-year debt crisis. On the other hand, the European Central Bank in the last meeting affirmed the leaders’ announcement and reassured that the Bank is not allowed and will not intervene in healing the debt crisis or act as a lender of last resort, where the European treaty prevents the Bank from providing direct funds to governments. Nevertheless, markets are still betting that in case the debt crisis threatens the currency union itself and impairs the transmission of the ECB monetary policies to the financial system and the real economy, the ECB will be forced to act against the treaty. Draghi also assured that the Bank’s focus will remain now on price stability and growth reiterating that the unconventional measures remain temporary in nature. However, the European Central Bank provided other tools to support growth and other nations, where the extraordinary measures included 3-year loans for banks with full allotment in addition to covered bonds and other tools used before the last meeting. The European Central Bank moved four times this year, raising rates two times and then lowering the rates by the same percentage, where the Bank raised rates in April and July by 0.25% to 1.25% and 1.5% respectively as Trichet was the President of the ECB, yet Mario Draghi in the first rate decision agreed with other policy makers to reverse Trichet’s moves after the euro-area nations slipped into “mild recession”. For Germany, the country continued in 2011 to reject the intervention of the European Central Bank and boosting the firepower of the European rescue fund, where Germany is the largest economy in the euro-zone and it will provide the largest portion, thus it will be highly exposed to the debt crisis and the possible failure of the Monetary Union, which in result means that Germany will play all its political cards before allowing the European Central Bank to intervene and act as a lender of last resort. 2011 ended with high volatility and heavy fluctuations in the market, stocks ended the year lower, while the common currency remained fragile and weak, and now our eyes will be focused on Europe and on the worsening debt crisis, where the first half of 2012 will give us indications whether the euro will survive and how European leaders will act and tackle the debt crisis in case they succeeded. 2012 Growth Forecasts for the Euro Area Region: The first half is the difficult half As 2011 came to an end, growth remained weak while the pace of recovery faltered, where the projections provided by major economic institutions in the world confirmed the slowdown in growth. The debt crisis is expected to worsen and deepen further at least during the first half of this year, awaiting European leaders to finalize their decisions and then the implementation of those measures shall decide the stance of growth over the following quarters. Moreover, growth is expected to slow further during this year, especially with the spending cuts and the further austerity applied that is expected to pressure growth further, where European governments are to apply further austerity in order to bring the budget deficit lower and to control the debt in attempts to strengthen the entire euro-area region’s financial position, which in turn could help in fighting the crisis and prevent the contagion from spreading further into other nations within the zone, debt woes spread after Italy and Spain became the main suspects of falling behind and following other weak countries into deep crisis. European nations in the December 9 summit decided to adopt a new intergovernmental treaty, where this treaty forces stricter budget rules on the euro area nations in addition to other non-euro countries that would like to join; however, these countries must at first get the back of their parliaments ahead of joining the euro-area nations in the new treaty, noting that all European nations except the United Kingdom are welling to join, yet further details will be provided with the start of this year as leaders attempt to finalize the decision as soon as possible to start the implementation quickly as time is running out and day by day market tension and volatility are intensifying, and in result the crisis is deepening. The euro area nations with this new treaty and the austerity measures needed to meet those targets are projected to pressure growth further, which in turn forced major economic institution to lower the euro-zone growth forecasts on several occasions during 2011, especially after the downbeat macroeconomic fundamentals, which showed that manufacturing and services sectors contracted in 2011, consumers confidence remained fragile and accordingly spending remained weak. The euro zone grew only 0.2% in the third quarter of 2011, unchanged from the previous quarter, where the slowdown in growth is expected to extend to the fourth quarter with the gross domestic product figures expected in the first quarter of 2012. But in general the European Central Bank foresees the annual real GDP growth in a range between 1.5% and 1.7% in 2011, between -0.4% and 1.0% in 2012 and between 0.3% and 2.3% in 2013. Moving to the Organization for Economic Cooperation and Development (OECD) projections, the organization projects the euro area region to grow by 1.6% in 2011, by 0.2% in 2012 and finally by 1.4% in 2013. The German economy, the largest economy in the euro zone, has weakened to the end of 2011 due to the fragile confidence and the escalating debt crisis in addition to the global slowdown, which hurt the nation’s exports. However, the OECD expects Germany to lead the growth in the euro zone, where the nation is projected to expand 1.8% in 2011, by 4.0% in 2012 and finally by 3.2% in 2013. For the second largest economy in the euro zone, France faces several challenges that are expected to continue affecting the economy in 2012, where rating agencies lowered the outlook for France which will be under review for a possible downgrade after rating agencies explained that expanding the contribution of France in the bailouts provided for nations will stretch the French budget and eventually it will cost France its triple A credit rating and with slowing growth more austerity is also needed to cut the debt and secure the top rating. The OECD projections for France showed that the country could have expanded by 1.6% in 2011, yet growth will slow in 2012 when the country is projected to grow only 0.3%; however, the pace of growth should accelerate again in 2013 as the organization projects the nation to expand 1.4%. Italy could have expanded slightly by 0.7% in 2011 according to the OECD; however, the nation is expected to contract in 2012 by 0.5% as Mario Monti, the new Italian Prime Minister pledged to apply further austerity to reduce the huge debt the country handles, which worth around 2.2 trillion euro, the largest amount of debt and the second highest debt-to-GDP ratio after Greece Spain on the other hand is expected to contract in the fourth quarter of 2011 as the global slowdown, the weakening exports and the surge in unemployment should affect the economy sharply; however, in 2012 the nations is projected to record 0.3% expansion. The International Monetary Fund (IMF) foresees the euro-area region to grow by 1.6% in 2011, yet the pace of growth will slow in 2012 to 1.1%. For Germany, France, Italy and Spain, the largest four economies in the euro zone, the Facility projected them to grow by 1.3%, 1.4%, 0.3% and 1.1% in 2012 respectively. The European Commission also expects the euro-area region to grow only 0.5% in 2012 and by 1.3% in 2013, while the entire European Union, which comprises the 27 European countries, could grow 0.6% and 1.5% in 2012 and 2013 respectively. At last, the World Bank projections for the euro-area region were relatively better than other economic entities, where the Bank projects the euro-area nations to grow 1.7% in 2011, while in 2012 the region is expected to gain 1.8% expansion yet likely to be revised lower as the year starts, at the time the euro zone will likely expand 1.9% in 2013. The Euro Zone 2012 Inflation Projections: Inflationary threats start to ease... In 2011, inflation in the euro area region reached 3.0%, above the European Central Bank target of 2.0%, where the Bank had to offer extra-ordinary measures in order to support growth and banks, which pushed inflation higher. In addition, energy and import prices remained relatively high, which in result added more inflationary pressures on the prices. The European Central Bank took rates back to their lowest on records after two moves that took rates shortly to 1.50%, where the bank had to act against its main mandate, which is maintaining price stability, in order to spur growth which was hurt significantly, affected by the escalating debt crisis and the global slowdown. The European Central Bank expects inflation to remain above the 2.0% target in the coming period, before undershooting the Bank’s target, where the Bank explained that it is essential for the current monetary policy to maintain price stability over the medium-term; however, since inflation is driven by temporary factors and it is projected to decline below the target in the medium-term, the Bank acted in favor of growth in order to prevent the region from slipping back into another phase of Deep Recession as so far the bank says the euro area is entering a “mild recession”. The European Central Bank reported that inflation could have lingered above 2.0% in 2011 in a range between 2.6% and 2.8%, while in 2012 inflation is expected between 1.5% and 2.5%, in the time the Bank projected inflation between 0.8% and 2.2% in 2013. The Euro Zone Monetary Policy Projections: Further Easing is Possible in the First Half, Rates Unlikely below 1.0% Unless the Bank was forced into Quantitative Easing The monetary easing seen in 2011, provided by the European Central Bank, is expected to continue and remain effective in 2012, where the bank adopted unconventional measures and offered banks with loans in order to spur growth and protect the financial sector from the escalating debt crisis. It has also coordinated with other major central banks across the world and provided European Banks with dollar funds and eventually lowered the benchmark rates to 1.0% in attempts to support European leaders’ attempts to end the debt crisis once and for all. The main movements provided by the ECB are explained below. The European Central Bank, the Federal Reserve, the Bank of Canada, the Bank of England, the Bank of Japan and the Swiss National Bank in coordination with each other agreed on November 30 to lower the pricing on the temporary U.S. dollar liquidity swap arrangements adopted in another surprise move earlier in the year by 50 basis points so that the new rate will be the U.S. dollar Overnight Index Swap (OIS) rate plus 50 basis points. This pricing will be applied from 5 December 2011. The authorization of these swap arrangements has been extended to 1 February 2013. In addition, the European Central Bank continues to offer three-month tenders until further notice. The Bank also explained in October that the Bank will continue money operations and offered 12 and 13-month loans for banks to support banks recapitalization, while the Bank also provided 40-billion euros program of covered bonds purchases. The European Central Bank (ECB) provided the euro-area banks on December 21 with 3-year loans, in attempts to provide liquidity to the market and prevent a credit crunch and an interbank lending freeze from hurting the financial sector while also eased the collateral rule and cut the reserve requirements. The bank will provide the second 3-year loan tender in February 2012. During 2011, the ECB bought large amount of European indebted bonds in order to ease market tension and control the rapid incline seen on yields, which reached unsustainable levels and raised concerns in the market that soon European indebted nations such as Italy and Spain will not be able to access the capital market and in result will not be able to meet their obligations and commitments and finally both nations will follow Greece, threatening the entire monetary union. However, and despite the large amount of easing provided for European Banks and nations, the debt crisis kept on worsening and growth kept on slowing, which also led the European Central Bank to lower key rates twice in November and December, reversing the former president’s movements of raising rates twice in April and July. In 2012, the monetary policy remains difficult to expect, as the European Central Bank will act in line with the economic events and the debt crisis developments, where in case European leaders were unable to finalize a comprehensive and strong plan to tackle the debt crisis and revive growth, the Bank will intervene then to save the monetary union, but still for now we do not expect any round of quantitative easing or bond purchases at the early stages of 2012. However, in case the European rescue funds, which comprises of the EFSF and the ESM, and the International Monetary Fund failed to quell jitters and stop the debt crisis contagion, the Bank could finally respond to the mounting market pressure and speculation of quantitative easing and bond purchases around the second quarter or mid-year, meaning that the European Central Bank will be forced to act against its mandate and become the lender of last resort. The Euro Zone Unemployment Projections: Unemployment to Remain High amid Further Austerity In 2011, the euro zone unemployment rate climbed above 10.0%, affected by the slowdown in growth and the faltering recovery, and also by the escalating debt crisis, which forced downside pressures on European nations and on the entire globe. We will track the debt crisis effects on rising unemployment now, where the escalating debt crisis as a start led European confidence to drop in the entire Union, and we all know that when consumers loose faith and confidence in the economy they tend to spend less and save more, and in result with less consumption and spending companies’ profits will weaken, which was seen clearly in Europe as the Manufacturing and services sectors contracted sharply in the second half of 2011, and eventually companies will have to cut spending in order to remain strong and avoid bankruptcy, thus employers will be forced to reduce the labor force significantly. Moreover, European governments adopted new austerity measures in order to cut their budget deficits, where with the further austerity expected in to be implemented in 2012 more employees are expected to loose their jobs as governments attempt to cut spending by reducing the operating costs of the public sector. In result, in case the European debt crisis continued to worsen and deepen and European leaders were unable to quell jitters by ending the two-year debt crisis, unemployment is projected to climb above the current rate of %10.3, where the OECD foresees unemployment to surge further in 2012 or at least to remain above 10.2%, while in Spain the Organization projects unemployment to hit the peak of 23.0%. Finally, economic institutions unanimously agreed that unemployment will remain above 10.0% in 2012, while most of them expect unemployment to surge in the first half of 2012, but then to start declining in the second half of the year if the debt crisis indeed started to be contained and the economy indeed remained in mild recession and then started to recover in the second half of the year according to the most balanced scenario expected. The EUR/USD Forecast: Euro to Loose Strength in the First Half, the Rest of the Year Depends on European Nations In 2011, the EUR/USD pair gained strength in the first half of the year, as European leaders were providing markets with solutions to the debt crisis which in result supported the confidence to remain strong that Europe is able to avoid a financial crisis and it will be able to overcome the debt crisis and growth will recover and eventually Europe will emerge stronger from the 2008 financial crisis. However, in the second half of 2011 the debt crisis started to worsen and deepen, while European leaders were not implementing any of the measures taken earlier, which triggered a drop in the confidence levels as investors were disappointed and lost faith in the euro area. Greece’s financial position also became critical in the second half, while larger economies started to follow Greece, Ireland and Portugal’s steps into deep crisis, which in result spread panic and renewed fears that Greece could default, pulling other countries into the debt-trap, which turned all the focus on Italy and Spain, the third and fourth largest economies in the euro area region respectively, with expectations they will be the next victims of the debt crisis in Europe. The EUR/USD pair opened 2011 at $1.3343, and recorded the highest at $1.4940 and the lowest at 1.2870 during the year. However, the pair is expected to remain fragile and weak in the first half of 2012, where the euro area region is expected to slip into recession in the first quarter of 2011, yet the reaction of European nations and the European Central Bank shall decide the Euro’s faith in the second quarter of 2012. Major Banks agreed that EUR/USD pair will decline in the first half of 2012, as median estimates are expected around 1.3000, 1.2900, 1.2900 and 1.3000 in the four quarters respectively. The highest level expected for the euro against the U.S. dollar was at 1.4800 to be recorded in the fourth quarter in case European nations were able to control and end the debt crisis. The worst scenario for the pair was reaching a low of 1.1300 also in the fourth quarter in case European nations failed to overcome the debt crisis and reduce market tension. European Stocks as well are expected to move in line with the common currency, where European Equities are expected to extend the losses in the first half of 2012 amid the escalating debt crisis and the possible recession; however in the second half of the year, equities are projected to rebound to the upside and to recover some of the huge losses incurred in the past years, where in case European nations tackled the debt crisis growth shall improve and in result European stocks should gain as well.