Austerity is a vicious process. In Spain finance minister Cristobal Montoro is desperately trying to square the circle of rising unemployment, a shrinking economy and the need to reduce the budget deficit. With more than half of his annual resources already committed to pensions, unemployment benefits and interest payments, that’s a tough job.
Montoro must raise cash – by selling government bonds – to bridge the gap between his shrinking tax revenues and rising fixed costs. Until Easter financial markets were not too worried by his predicament. Greece had negotiated its way through what EU leaders promised would be a one-off default. It would never happen again. The European Financial Stability Facility and its successor, the European Stability Fund, would erect a firewall around southern Europe so that investors would no longer fear for the credit-worthiness of eurozone nations.
Then, in an unfortunate coincidence, two things happened at once. Spain tried to auction €5bn of short-term government bonds but only managed to sell €3.6bn of them at any sensible price. On the same day the European Central Bank made clear there would be no repeat of the so-called Long Term Refinancing Operations that took place in December and March, putting more than €1trn into the hands of eurozone banks at low rates of interest. It did not take anyone long to cotton onto the idea that only when wedged up with cheap money would European banks have any enthusiasm for the government bonds of the southern European Club Med countries.
The spectre of ‘contagion’ has reared its ugly head again and the euro is worried, but in the US things are looking up. After being pigeonholed during and after the global financial crisis as a safe-haven currency, the dollar is looking more like a mainstream currency. It is now rising and falling according to investors’ perception of the US economy rather than as a result of their mood swings between pessimism and optimism.
That conceptual switch was made clear during the week before Easter. First, the minutes from the Federal Reserve’s March policy meeting suggested that renewed asset purchases (quantitative easing, printing money) were falling out of favour among policy-makers. Investors thought that was good for the dollar because it meant the currency was less likely to be diluted. They bought it. A couple of days later, on Good Friday, the Bureau of Labor announced that non-farm payrolls had risen by only 120,000 in March. Until recently that would have been a buy signal for the dollar, inasmuch as it was a negative signal for the global economy. But this time it sent the dollar lower. Investors are looking at the US eco-stats as pointers for the US currency, not as indicators for the world as a whole.
The green shoots of economic spring have also become evident in the UK. Purchasing managers’ indices for the manufacturing and services sectors in March were better than anything the eurozone could offer. They were both comfortably above the growth/contraction dividing line.
Moreover, sterling is flexing its muscles against the euro. Over Easter the pound nudged its January highs against the euro and threatened to break above the five-year moving average. The pound’s immediate problem is that nudging and threatening do not amount to a breakthrough. While immediate upward progress is possible, it is easier to imagine first a return to the range that held it for the first three months of the year – because you can just imagine the queue of sellers lining up to sell pounds at a 41-month high.
