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Friday, July 26, 2013

Europe Looks Fine Now, But A Political Perfect Storm Is Brewing

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Economic data out of Europe has been improving, showing that the eurozone is stabilizing.

And concerns of a major European crisis have been fading.

The OMT program, open market transactions, a bond buying program the ECB launched following Mario Draghi's promise to do "whatever it takes," has not yet been tested.

But Nomura's Alastair Newton thinks that the time could come in the fall when the OMT will come into play.

"We think that it would probably take several ‘bad’ events occurring simultaneously for there to be a significant possibility of OMT having to be activated," said Newton. "The multi- dimensional nature of the eurozone crisis appears to allow for this possibility, as illustrated by the following non-exhaustive list of ‘issues’ which could flare up in September/October."

Here's a quick look at what Newton's worried about:

  • France - The government commission on pension reform will report at the end of July, this is ahead of the introduction of new legislation in August. "With left-wingers in President François Hollande’s Parti Socialiste threatening a revolt and the unions girding themselves to take to the streets, the government is facing what markets see as an acid test of its ability to deliver reform," Newton writes. Meanwhile, if France fails to do more to reduce the deficit, it risks criticism from Berlin and Brussels and from peripheral European countries pointing out double standards.
  • Germany - German policy isn't expected to soften after the general elections scheduled for September 22. But "pressure from the peripherals and from France for a shift may increase, risking open disagreement between Berlin and other eurozone capitals,' warns Newton.
  • Greece - The troika — European Commission, IMF, and the ECB — will review Greece in October, and talks of foreign debt restructuring may surface again. "Although this would hardly come as a surprise to markets or German voters, the prospect of official creditors (including Germany) taking a hair-cut over Greece could raise concerns over similar steps proving necessary for Cyprus and already troubled Portugal."
  • Italy - The ruling coalition in Italy should struggle but stay in power going into 2014. But if there are still differences going into fall, the property tax will complicate "what promises in any case to be a contentious 2014 budget process."
  • Spain - An upward shift in Italy's yield curve could cause a similar move in Spain's yield curve. Spanish prime minister Mariano Rajoy is still caught up in a slush fund scandal, former People's Party treasurer Luis Barcenas is said to have run a slush fund and sent money to party officials including Rajoy. All of this could see Spain being pushed to a bailout.

Amid all these, the 2014 European Parliament elections will also be weighing on Europe's biggest players. Newton thinks "conditions are ripe for extremist parties to make significant gains in these elections," making policy decisions even harder.

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READ THE ORIGINAL POST AT www.businessinsider.com