Spanish Prime Minister Drops 2012 Reelection Bid; Trichet Transforms Into Hawk; What Does it Mean for the Euro? The Dollar?

Spanish Prime Minister Jose Luis Rodriguez Zapatero, has decided to not seek reelection in the March 2012 election. Zapatero has been the driving force behind various austerity measures in Spain.

Will Zapatero will push for even stronger austerity measures before his term expires? That seems doubtful although by dropping out, concerns he may have had regarding voter backlash would shrink. His austerity measures have been very unpopular with voters in general but investors have cheered.

Conviction to Stay the Austerity Course in Question

Will the next government have the political will to stay the austerity course?

Please consider Spain’s Deficit Fight Risks Setback as Zapatero Quits Election

Spain’s efforts to reduce its budget deficit and rebuild investor confidence may suffer a setback as Prime Minister Jose Luis Rodriguez Zapatero bows out of next year’s election.

Zapatero, 50, said on April 2 he won’t seek a third four- year term, forcing his party to select a new candidate a year before March 2012 elections. The Socialists, which are trailing the opposition in opinion polls, will hold primaries after regional and local elections on May 22, Zapatero told party members in the capital Madrid.

Investors had rewarded Zapatero’s austerity package, Spain’s toughest in three decades, sending the country’s borrowing costs lower even as bond yields in neighboring Portugal soared to euro-era records. The currency bloc’s fourth- largest economy now faces a period of political uncertainty that may disrupt measures crucial to Spain’s fiscal survival.

“The politics are turning more difficult,” said Stuart Thomson, a Glasgow-based fund manager at Ignis Asset Management, which oversees about $120 billion. “There has been a lot of money coming into Spain; it started to underperform on Thursday and Friday and I suspect that underperformance will continue as a result of this.”

Spain is the latest in a list of euro-area countries facing political upheaval after voters in Ireland ejected the Fianna Fail government from office in the wake of a bank crisis that left it in need of an 85 billion-euro ($121 billion) bailout. In Germany, Chancellor Angela Merkel’s Christian Democrats have been punished in local elections as voters balk at the prospect of funding bailouts elsewhere in Europe.

Portuguese Prime Minister Jose Socrates resigned on March 23 after failing to win support for austerity measures.

Zapatero, a Socialist who in 2005 said he slept with his union card by his bed, made a policy U-turn in May amid Greece’s fiscal crisis. He cut public wages 5 percent, reduced pensions and benefits and pushed labor-market reforms that made it cheaper for companies to fire workers.

Those measures, while popular among investors, prompted the first general strike in eight years and undermined the ruling party’s popularity. The highest unemployment rate in Europe, at more than 20 percent, has also eroded support for the Socialists.

The number of people registering for jobless benefits rose for a third month in March, the Labor Ministry said today. Consumer confidence in March declined to the lowest level this year, according to a separate report from Instituto de Credito Oficial.

The opposition People’s Party led by Mariano Rajoy enjoys 44.1 percent voter support, compared with 28.3 percent for the Socialists, according to an April 3 El Pais poll.

Poor Economy, Poor Prospects

By resigning, Zapatero has prematurely made himself a lame duck. The odds he could win support for additional austerity measures seems slim.

Regardless of what Zapatero does in the interim, the next prime minister will inherit a poor economy, and an even worse setup, especially in regards to policy Spain has no control over.

ECB president Jean-Claude Trichet seems hell-bent on hiking rates and that cannot possibly help prospects for a Spanish recovery.

Trichet Seen Burying Ailing Nations With Rate Rise on Inflation

Please consider Trichet Seen Burying Ailing Nations With Rate Rise on Inflation

Jean-Claude Trichet’s shot against inflation may end up inflicting collateral damage on Europe’s most cash-strapped economies.

Primed to raise its benchmark interest rate this week for the first time in almost three years, President Trichet’s European Central Bank again faces the conundrum that its monetary policy rarely suits all 17 members of the euro area, where the kaleidoscope of growth ranges from record expansion to recession paired with a sovereign-debt crisis.

The upshot may be that the normalization of rates from a record low of 1 percent will disproportionately hurt Spain, Greece, Portugal and Ireland, while failing to nip inflation threats in Germany. Such uneven fallout risks exacerbating the two-speed European recovery and dealing further damage to the bonds of so-called peripheral nations. Credit Suisse Group AG is warning investors away from the region’s stocks and banks partly because of concern the ECB is making a policy mistake.

“As the ECB continues to tighten, it increases the risk that the sovereign-debt crisis comes back,” said Gavyn Davies, chairman of London-based hedge fund Fulcrum Asset Management LLP, which oversees about $1.5 billion in assets. “It will manifest itself with the troubled economies moving into slower growth rates, and the fiscal arithmetic will worsen again.”

Economies from Ireland to Spain are buckling under record debt burdens and the bursting of property bubbles, even as Germany expanded 3.6 percent last year, the strongest pace in two decades. In forecasting euro-zone growth of 1.6 percent this year, the European Commission predicts expansion of 2.4 percent in Germany, three times the anticipated rate for Spain, where unemployment is 20 percent, the highest in the region.

The situation is a “precise reverse” of the period before December 2005, when the ECB last began raising rates, said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. Then Germany was weak, with growth of 0.8 percent that year, while the Irish and Spanish economies expanded 6 percent and 3.6 percent.

“We were in a world where rates were much too accommodative for the periphery and much too tight for the core,” Kounis said. “Now, the situation is the same, only the countries are different. It’s a problem with their one-size-fits-all policy.”

One Size Fits Germany

I wrote a similar column on March 8, 2011: ECB's "One Size Fits Germany" Policy

Trichet Transformation Into Monetary Hawk

Bloomberg reports Euro Has Best First Quarter as Trichet Transforms Into Hawk

The euro, seen as a potential failure 10 months ago, had its strongest start to a year on record as German growth accelerates and policy makers prepare to boost interest rates.

The currency appreciated 3.5 percent through March, the most since the final three months of 2008 and the best first- quarter performance since the region’s single currency began trading in 1999, according to Bloomberg Correlation-Weighted Index data. It rose from its lowest level since 2002 in January as German Chancellor Angela Merkel and French President Nicolas Sarkozy said they would do whatever is needed to support the 17- nation monetary union.

While Portuguese bonds show increasing speculation for a default and regulators said four Irish banks need to raise 24 billion euros ($34.1 billion) in capital, currency concerns have faded since last year, when former Federal Reserve Chairman Paul Volcker and billionaire investor George Soros said the union may dissolve.

“The euro is extraordinarily strong under the circumstances,” said Alan Ruskin, global head of Group-of-10 foreign-exchange strategy at Deutsche Bank AG in New York. “Does it look more capable of stumbling along than it did a year ago? Yes, to the extent that the core does seem to have made a commitment to fund bailouts.”

“For some countries a rate hike doesn’t fit, especially for Portugal and Greece, but also partly for Spain, where there is a problem with mortgages,” said Ulrich Leuchtmann, head of foreign-exchange strategy in at Commerzbank AG in Frankfurt, who expects the euro to end 2011 at $1.32 as the Fed begins to reduce its aid to the economy. “We’ll have a rate hike, and this will obviously create problems.”

John Taylor, chairman of New York-based FX Concepts LLC, the world’s largest foreign-exchange hedge fund, predicted in January that the euro may fall below parity with the dollar this year. Now he says the current rally may not last. Taylor, whose firm oversees about $8.5 billion, profited in the first half of 2010 betting on a slide in the currency.

“I’m sounding pretty stupid; but on the other hand, I’m not ashamed and I’m sticking with it,” Taylor said last week in a telephone interview. “Europe, with all the tightening that’s being forced on these countries, will be in a recession by the end of the year. There’s going to be a restructuring and default of the European debt.”

“The market can whip you up into a frenzy where you become irrational,” said David Bloom, the global head of currency strategy at HSBC Holdings Plc in London, who said in June the euro would end 2010 at $1.35. “The difference this time around is that there is a mechanism in place. The break-up premium has come out of the euro.”

Sympathy of the Euro Bears

I sympathize with the Euro bears, after all, I have been one too. The Euro has risen in expectation ....

• The European sovereign debt crisis is over
• Trichet will hike multiple times regardless of what it does to the European economy
• Trichet will hike regardless of what it will do to the PIIGS
• Spain will not need a bailout
• Ireland, Greece, Spain, and Portugal will not default
• Bernanke will start QE III
• US Congress will do nothing to solve the deficit
• Other Central banks will hike, leaving Bernanke isolated
  

That is a lot of ifs. I do not think Bernanke will start QE III any time soon and if he does it may be in the context of central bankers in general engaging in widespread debasement of their currencies.

Certainly I do not expect Congress to solve the budget deficit. However, I do think Congress will make some progress. Is any progress priced in?

Please see Government Shutdown Battle to Be Followed by Bigger Fight; GOP wants $4 Trillion in Cuts Over Next Decade; Is that Enough? for a discussion of budget battles.

For now, Ireland Caves in to Trichet. In response, Nouriel Roubini said "Eventually, the back of the government will be broken." The same applies to Irish taxpayers.

How long will Irish taxpayers put up with bailing out the German, French, and British banks that foolishly lent Ireland money?

Moreover, it's not just the Euro that is overpriced. Chinese banks are as insolvent as they come and China is likely headed for a market-imposed slowdown. For a discussion, please see Hidden Losses and Little Reform; China May Be Slowing More Than You Think.

The love affair with the Australian dollar given its property bubble that is imploding now certainly seems questionable. Look for the Australian retail sector to follow the housing market lower. If so, I suspect the next rate move by Australia's central bank will be lower, not higher. If the Reserve Bank of Australia starts cutting rates, that would be net negative for the Australian dollar.

That Japan will print more in wake of its nuclear crisis seems a given. Unless Yen printing will be balanced by more Japanese tax hikes, the Yen setup is also net dollar friendly.

Finally, anti-dollar sentiment is once again near record highs.

Sentiment itself is not a timing mechanism as things can always get more extreme. However, a lot of things need to happen to merit increased strength in the Euro, the Yen, the Yuan, and the Australian dollar.

For now, the market has other ideas, but I like the setup here for renewed dollar strength.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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