There is one main feature of the euro zone economic data next week. Yet the flash PMI readings are unlikely to be sufficiently different from the July readings to prompt a reassessment of the trajectory of the regional economy. More important than the economic data will be the political maneuverings.
There will be a flurry of meetings between Antonis Samaras, Angela Merkel and Francois Hollande. Nearly three years after the Greek crisis began, it is still not on a sustainable path. After agreeing to new austerity measures, despite the economy contracting for its fifth year, Samaras appears seeking some breathing space of its official creditors after having given the private creditors a significant hair cut earlier this year. Samaras is seeking a two-year extension of it fiscal targets. Such a request is not completely unprecedented. Recall the EU granted Spain a 1-year extension after Prime Minister Rajoy unilaterally lifted its own fiscal target.
There are two basic points that Samaras, Merkel and Hollande seem to agree. First, Greece must adhere to its commitments. Second, it has little chance of fulfilling those commitments. The problem lies in what follows from this.
Despite what Der Spiegel has called "shrill threats" from some of Merkel's German allies, there does not seem to be broad support among the European elite to force Greece out of the union at this juncture. The other political reality is that officials in the creditor countries, not just Germany, but others as well, do not appear to have the political capital to secure additional support for Greece.
It is not so much that a decision to grant Greece a two-year stay would require parliamentary approval, but it could trigger a domestic backlash. The Netherlands, for example, hold national elections on September 12, the same day the German Constitutional Court is expected to make its preliminary ruling. Although the likely configuration of the next government is not clear, there does seem to be a recognition across the parties that there is not much appetite for additional austerity or aid measures.
The last week of August and early September will see more jockeying for position. There will be more meetings with Rajoy, Monti and Merkel. While the statements will all be supportive and cordial, these are not the forums for key decisions. For Greece, no decision is likely until after the Troika's October report. This means that the Oct 18-19 heads of state summit is the key.
In addition to Greece, Spain is also under some pressure. The ECB increased the pressure on Spain by limiting the government-guaranteed bonds it will accept as collateral. That meant, in effect, that Spain could not bail out Bankia as others, like Dexia, were with government guarantees rather than new capital infusions. Some Spanish banks are believed to be nearly out of acceptable and unencumbered collateral. The rally in Spanish bonds (bullish flattening as the 10-year yield has fallen 32 bp in the past five sessions, while the 2-year yield is off 8 bp in the same time) appears to be largely a function of short-covering in anticipation of ECB/EFSF buying as early as next month.
We remain suspicious that a rally for the lower yields in Spain effectively ease the pressure on Rajoy to formally request such assistance (separate from the 10 bln euro bank backstop). We also recall that past ECB purchases did not have a significant or sustained impact on yields. There is a risk of "buy the rumor, sell the fact" type of response to the official purchases, which we also fear will contribute to the private sector financial disintegration (fragmentation). Lastly, on news that the ECB will buy Spanish bonds, we suspect that Italian bonds will under-perform Spain as investors begin anticipating the next domino.