Three Political Events that Should be on Your Radar
By Marc Chandler
Tomorrow’s EU Summit is the markets main focus. The key issue is whether European officials can finally provide closure to the two year old debt crisis and deliver the "comprehensive" and "decisive" package they have repeatedly promised. We are skeptical as governance structures and diverse interests of the stakeholders lend itself to incrementalism.
Outside of the EU Summit there are three political issues that do not seem to be appreciated by many participants. These events can have dramatic implications for the economic and financial outlook.
The first is the vote in the German Bundestag tomorrow before the EU Summit. Merkel has capitulated in the face of strong domestic pressure to have a full vote in the lower house of parliament on the plans to boost the EFSF(leverage). This was agreed to just yesterday. Originally, Merkel had hoped to simply get the budget committee’s support, but succumbed to the opposition pressure and some rebels in her own party.
There is concern among some CDU/CSU MPs that although the German guarantees to the EFSF will not be raised, its share of the EFSF will not be diluted by increasing the size of the EFSF, there is concern that the leveraging plan may result increasing Germany’s real financial commitment.
The recent Constitutional Court ruling has enhanced the "sovereignty" of the German parliament on budgetary issues. There is a good deal of variation among parliamentary governments. Denmark and Finland, for example, have relatively strong parliaments. The German Constitutional Court rulings appear to be pushing Germany more into that model. Recall in the late Sept vote to enlarge the EFSF effective lending capability to 440 bln euros, Merkel garnered an absolute majority, despite 15 MPs from her coalition opposed the government.
It is again important for Merkel to secure an absolute majority even though a simply majority will suffice. It may be more difficult to achieve that it was in late September. Some of the skeptics fears have indeed materialized in recent weeks. In late Sept, the opposition Social Democrats and Greens supported the government. This time they are keeping their cards closer to their vests.
Press reports suggest that the complicated documentation was not provided until last night from Brussels and it was in English. Today will be spent discussing it, but the point here is that the political risk in Germany has risen.
The second important political development that seems under-appreciated is the implication of comments from Greek Finance Minister Venizelos. He indicated that the Greek parliament will vote on outcome of the EU summit and that it will require a super-majority for approval. This is a high bar for a government that has a slim 153 seat majority in the 300 member house. The super-majority is 180.
The opposition has already indicated it will not support the government. It prefers an early election for which the polls suggest the governing Socialist would be voted out of office. There are a few smaller non-aligned parties, but they do not have the numbers, even if they all were to support the government, to ensure passage.
The other two euro zone countries, Ireland and Portugal, that have received assistance have new governments. The Greek Finance Minister comments warn of the risk that the Greek government collapses. This will inject an additional element of confusion and risk for investors.
The third political risk emanates from Italy. As Europe moves to build a fire wall around Italy and Spain through the EFSF, Berlusconi was apparently called to the proverbial woodshed and chastised by Germany and France. They seem loath to assist Italy, but know that much is at stake. They hoped to get some concessions from Italy, but yesterday’s cabinet meeting failed to take any action, including raising the retirement age to 67, as it was blocked by Berlusconi’s ally the Northern League. Berlusconi appears to have gone from the defensive to the offensive, noting that Italy has a larger primary budget surplus than its critics and will reach a balanced budget by 2013. The risk of growth disappointment warns that Berlucsoni may be in danger of overstating his case.
Moreover, the French are particularly perturbed with Italy. As of November 1, when Draghi takes the reins of the ECB, there will be no French on the board and two Italians. ECB members have been reluctant to criticize Bini Smaghi for not resigning to make room for a French candidate as the independence of the central bank is understood to be at stake. It is also ironic that when it came to the head of the IMF, many European officials claimed nationality did not matter in response to a push to have the post go to the emerging markets. Apparently, the ECB is a different matter and nationality does matter.
In any event, the fact of the matter is that Berlusconi has barely survived a number of confidence votes. Many expect the economy to slip back into recession (slip is the right word as growth has not been very strong at 0.1% in Q1 and 0.3% in Q2). The fragility of the Italian government is a threat to stability not just in Italy but in the euro zone as a whole.
Taken together than separately, these three political considerations warn of the downside risk in the euro in the near-term. The euro has approached the 61.8% retracement of the September swoon from $1.4550 to $1.3850. We suspect that the bulk of the euro’s rise can be explained through short-covering rather than the establishment of new longs and appears to be running out of steam.
In addition, given the record (since at least the early 1990s) correlation between the euro and the S&P 500, we should include an outlook of the S&P 500 in our euro view. The S&P 500 is approaching a key band of resistance in the 1260-1275 area. A topping of the S&P 500 is likely to correspond to the topping of the euro. Initial support for the euro is seen near $1.3840 and then $1.3770.