The weight of all the grim economic data finally got to the market last week.
Almost every US data release last week was disappointing. And on Friday, the ECRI Weekly Leading Indicator saw its growth rate plunge to -9.8%. That’s just above the -10% rate which has historically predicted recession. And there were plenty of other things to worry about, including weak manufacturing data.
The Dow Jones tumbled by more than 250 points. The dollar continued to slide against the euro as fears of a double-dip grew.
But just in case investors were thinking of taking their eyes off the eurozone, the weekend threw up yet another European crisis-in-the-making.
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Hungary had a bit of a falling out with the International Monetary Fund. And it could remind investors of just how fragile the situation in Europe really is…
Stress test speculation is unnerving investors
Europe is back in the spotlight this week. Investors were already fretting about the European banking stress tests this Friday. No one is quite sure of what’s going to happen. But everyone is scared the process will be chaotic and unconvincing.
For one thing, the criteria are uncertain. But most pundits seem to think they’ll be too lax to be at all credible. Already Germany and Ireland are suggesting their banks will pass with flying colours. As Tamara Burnell of M&G Investments points out, this “highlights how pointless the whole exercise is looking, given these two countries’ banks have very clear and obvious problems.”
The fact that German Landesbanks claim to be “‘very relaxed’… is particularly worrying, given the track record of Landesbanks having to admit to chunky losses on virtually every problem asset class.”
Secondly, you can’t compare this to when the US conducted its banking stress tests. As Mohammed El-Erian of Pimco pointed out in the Financial Times, in the US, the banks were the cause of the problem. In Europe, fears over the banks’ solvency are just a symptom of a deeper issue. They reflect “worries about sovereign debt in some countries and the overall economic situation; and there are greater limits today on budgetary resources.”
In other words, as Felix Salmon points out on Reuters, when the US stress-tested its banks, no one was worrying about government debt. They knew the government could step in and bail out the banks. But in Europe, the only reason investors are worried about the banks in the first place, is because of the threat that a country might go bust.
So the last thing Europe needed was yet more news to fret about ahead of the release of these results. But that’s exactly what it got this weekend.
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What is happening in Hungary?
The International Monetary Fund (IMF) and the European Union (EU) ended talks with Hungary’s government on Sunday, “without endorsing Prime Minister Viktor Orban’s plans to control the budget deficit”, as Bloomberg reports.
The Hungarian government wants the IMF and EU to allow it to run a wider budget deficit in 2011. It blames the previous government for fiddling the statistics in the first place. This caused a spasm of panic in the markets earlier this year when it warned Hungary could face a Greece-type situation.
The two sides have to agree in order for Hungary to get access to the next phase of an IMF credit line. Up until now, investors had been assuming that this money would be a foregone conclusion. That means that so far, Hungary hasn’t been relying on the bail-out loan – it’s been able to raise money from the market.
But this might change if investors realise the IMF is no pushover. As Peter Attard Montalto of Nomura tells Bloomberg: “For an IMF statement, it’s pretty damning. This supranational cushion behind Hungary is actually far softer than people realise.”
One Budapest-based fund manager warned: “This news is very negative. This won’t be the type of sell-off where the smart investor is buying.”
The resulting plunge in the forint (which fell sharply this morning) will make life more expensive for Hungarians who took out home loans denominated in foreign currencies. That in turn is bad news for the lenders who extended those loans in the first place. Because it means more of those debts will go bad.
Hungary’s problems are bad news for the rest of Europe
Again this displays the triumph of politics over economics. As Montalto put it, the failure of the talks is “very rare. Countries usually go out of their way to satisfy these missions.” It’s a reminder to markets that when countries are given the choice between satisfying foreign lenders and keeping the people at home happy, they’ll often choose to stiff their creditors.
And if Hungarian voters aren’t prepared to buy into austerity packages, you can bet that the Greek people aren’t going to be deeply happy about it either. Oh, and just for good measure, credit rating agency Moody’s even downgraded Ireland this morning.
If even the best-behaved of the troubled peripheral eurozone countries can’t catch a break, what does that say about the rest of them? The euro is rebounding right now and we wouldn’t get in the way of that – we warned to close out any euro / dollar shorts you still had in the cover story in MoneyWeek magazine a few weeks ago: What to buy as the recovery stalls. (If you’re not already a subscriber, subscribe to MoneyWeek magazine.)
But the single currency is still on thin ice. In the longer run, it has a lot further to fall before this crisis is resolved.
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