Market focus returns to Europe

10 February 2017

Market focus returned to Europe as US president Trump made his first sobering experience with the nation's well-established system of checks and balances, when the judiciary arm threw out his travel ban as potentially unconstitutional. While he made clear he would hold judges responsible for any future misdemeanours of '˜aliens' on US territory he tried to instead progress his business agenda through an executive order to roll back most of Obama's tightened post crisis bank regulation and hinting at a 'phenomenal' tax reform announcement in the coming days.

Stock markets rallied on the prospects and in delight over strong corporate results as companies publish their earnings figures for the last quarter of 2016. However, as we point out in the next article, the growth dynamic baton is seemingly being passed on from US (and UK) companies to those domiciled in Continental Europe and Japan. Not only this, but most political commentators have cast significant doubts over the time lines of Trump's tax and trade reform. Given tax cuts would have to be counterbalanced by new revenues from import taxes, the former depends on the latter and the latter can't be introduced overnight without risking a much worse implementation chaos and legal challenges than the travel ban brought.

This gives the big fiscal stimulus and tax reform more of a 2018 perspective, which leaves us concerned that either the rallying markets will be left disappointed by the forthcoming 'phenomenal' announcement or Trump risks making another highly unrealistic promise only then to blame non-delivery on his adversaries.

Sadly, the cause for Europe returning into the Global market limelight was not the lack of further US policy upsets, but a combination of Brexit progress, French election noise and the return of the Greek debt crisis evergreen. The UK parliament's House of Commons bowing to the outcome of the Brexit referendum and empowering the government to give formal notice to the EU of the country's desire to leave the European Union has put the UK one step closer to getting on the path of inevitable exit from the trade benefits of the largest economic bloc in the world and the uncertainty of the trading environment we enter into thereafter. Currency markets appeared unimpressed by the prospect with £-Sterling depreciating against the US$ and other currencies.

Over on the Continent, April's French presidential election suddenly looked more winnable for the populists, as the hitherto leading conservative candidate Fillon became embroiled in a scandal of misuse of public funds to employ his wife and children in pseudo jobs. Markets reacted nervous, increasing the French government's cost of borrowing, although political insiders didn't change their view that Front Nationale's Mariene Le Pen would only likely win the first round of the election but not succeed in winning the second, final round.

Even more attention was given to news that there is renewed quarrel over the ongoing terms of the Greek debt bailout. It seems that politicians' attempts to making sure the Greek debt issue will not raise its divisive head during the forthcoming elections in France, the Netherlands and Germany have backfired. The International Monetary Fund (IMF), took the opportunity to warn that in its view the ongoing burden of the historic debt remained too high to ever allow Greece to prosper again. While German government representatives vehemently disagree to any further debt forgiveness they have also said that they would not continue to support even the existing bailout arrangements, should the IMF withdraw its involvement.

As we have written here over the past 4 years, the Greek public debt issue is truly tragic and every renewed bailout failed to recognise that the country has been allowed to become over-indebted which is to no small extent also to be blamed on reckless lending by their Northern European creditors. As long as the creditors feel unable or unwilling to formally write off their demands, Greece will be condemned into eternity to regularly approach national default, until their creditors once again extend payment terms.

The IMF rightly points out that this is not fair and violates their fundamental belief and objective to reforming over-indebted countries within finite time scales. Their European counterparts argue that no harm will come to Greece as long as the big European countries extend them their low rates and very long repayment terms and Greece in return continues to repay its historic debt through a continuous annual budget surplus of 3.5%(!!!).

I personally do not believe that the EU will, during 2017, allow the Greek situation to deteriorate to crisis level again while German politicians are seeking re-election. However, the German government may be forced to either accept the IMF's demands for a lower Greek budget surplus target or see the IMF exit the bailout triumvirate to leave World Bank and EU to deal with future crises on their own. Wolfgang Schaeuble's (German finance minister) unveiled threat that Greece would have to leave the EU if it asked for further debt reductions does not strike me as a particularly wise opening gambit, when the biggest threat to the EU this year is its continued cohesion as a union.