In today’s links were two articles which highlighted the juxtaposition between declining sovereign bond yields and worrisome economic fundamentals in Spain and Portugal. Both are from Reuters. In the wake of the Draghi Put that the ECB applied with the announcement of its OMT program, yields in the periphery have come way down. Meanwhile the economy on the ground is still terrible. In Spain and Portugal in particular, this is worrisome.
Here’s what Reuters had to say in the first article; the headline – Worst may be over for euro zone factories – tells you the story:
“While the industrial sector looks likely to have acted as a drag on the euro zone economy in the final quarter of last year, deepening the double-dip downturn, the PMI provides hope that the first quarter could mark the start of a turnaround,” said Chris Williamson, chief economist at Markit.
“Providing there are no further setbacks to the region’s debt crisis, these data add to the expectation that the euro zone is on course to return to growth by mid-2013.”
The truth here is that Germany is the country where the data looked most promising, with manufacturing output moving from contraction to expansion. France’s manufacturing sector plunged deeper into recession while the manufacturing sectors in Italy and Spain moved in the right direction but also remained in recession. So the headline doesn’t get it right. I see the data as inconclusive.
Meanwhile, another Reuters article has a more realistic view of the situation in Europe. Focusing on Portugal, it sees the situation as a mixed bag. “Investors cheer Portugal, on ground situation bleak” gets it about right.
In perhaps the starkest example of the gap between renewed investor appetite and languishing economies, Portugal has started 2013 on its strongest footing since it was bailed out in mid-2011, with confidence boosted by hopes it will relinquish its lifeline from the European Union and IMF as scheduled.
Investors bought 2.5 billion euros of Portuguese 5-year bonds last week in the country’s first issue since its bailout, returning it to the market many months earlier than planned. Struggling Spain and Italy have benefited from similar bond market largesse.
Yet on the streets people are braced for severe hardship in 2013 as they lose up to two months’ wages to the tax man after years of grinding austerity.
With almost a sixth of the workforce unemployed and shops and restaurants shut down in record numbers, selling bonds or improving the current account deficit is meaningless to ordinary people.
“The government bangs on about a lot of stuff but down on the ground things are different. The return to the (bond) markets was a farce, it means nothing to me,” said Adelino Santos, 54, who works for Portugal Telecom in Lisbon.
“I am bracing myself for the hammering of the tax hikes when they kick in. Unfortunately, I think 2013 is going to be even worse than 2012.”
The situation in Spain is similar. The website CincoDias was just happy that the Spanish manufacturing PMI showed manufacturing in Spain declining at a slower pace. They touted the fact that it was the slowest pace since June 2011.
So, the right view here is that austerity is killing these economies but they do have access to bond markets at better yields because of the ECB backstop. I don’t think that’s enough for us to hang our hats on. And the investors piling into Portuguese and Spanish bonds are showing a huge amount of complacency given the still difficult economic environment in those two countries. This is clearly a case of risk seeking return in a low interest rate environment.
Morgan Stanley had a note out today saying that euro sovereigns looked the more vulnerable to them than at any point since the Draghi “whatever it takes” statement. I would agree here. If you look at the periphery, Italy and Ireland are recoupling to the core and Greece is seen as a hopeless case. Spain and Portugal are where the greatest question marks have to be.
In both cases, I believe the austerity is too heavy and the deficit targets too ambitious for them to be achieved. At some point later this year, we will see both countries miss their targets as their economies underperform expectations. I, therefore, expect yields to back up until it is clear that the targets can be relaxed or until the countries formally request an OMT program bailout.