A breather from Brexit? ..... not really, but some different angles at least: Italian Banks, Spanish Elections and the Fed.

Tuesday 28th June 2016

A breather from Brexit ? ..... not really, but some different angles at least :  Italian Banks, Spanish Elections and the Fed .

ref :- "Italy resurrects plans to rescue struggling banks", The Financial Times , Brexit section

ref :- "Rajoy defies poll odds but coalition challenge looms", The Financial Times, International

ref :- ""Short view", Jennifer Hughes in The Financial Times, Companies and Markets

You can't escape it, really ..... even if you begin to study an article that at first glance would not seem to revolve around Brexit, just at the moment you know it'll come back round to the subject at some point or another. Fair enough ..... Brexit really is that big a deal and the vote will go down in history as a seminal moment, and not just for economists. Still, it may come as a relief (to Anglos at least) to take a quick look at some other pieces that nominally concentrate on wider topics. Rather that than more on financial meltdown and political chaos ..... or football.

Now here's something worth knowing : Italy has 600 separate banks and their branches outnumber the country's pizzarias. Those acquainted with Italy (and its pizzarias) will appreciate what a staggering statistic that is, but it should come as no surprise therefore that Italy's banking system, and its fragmented structure, is beset by deep concerns about its exposure to bad loans, weak profitability and governance issues. Italian premier Matteo Renzi would like to wade in with state aid for the banks, but EU regulations do not allow such a move in current circumstances and insist on Italy implementing EU-wide "bail-in" rules, whereby the burden of rescuing any failing bank is pushed onto private creditors rather than the taxpayer.

Sadly, this method of protecting Guiseppe Taxpayer has resulted in the high-profile suicides of several bankrupt bank creditors, the latest one as recently as last week. Unsurprisingly, the EU's rules are not universally popular and with Mr Renzi's party suffering heavy defeats at the hands of the populist Five Star Movement in mayoral elections in Rome and Turin just a week ago, you can understand how winning back some popularity might be at the top of his "To Do" list.

Back in April the government did sponsor (amidst considerable fanfare) a privately-financed bank rescue fund, catchily named Atlas. You could say that fears that its capital of 5bn euros would prove "inadequate" have proved to be on the mark .... even senior Italian bankers reckon the sector needs backing to the tune of 40bn euros. Other, international officials argue that even this figure significantly understates the problem. Not much help then, and hence Mr Renzi's enthusiasm for the state to assume the risk. The only way that EU regulations which currently proscribe such a course would be relaxed would be if Mr Renzi is successful in convincing the EU that state-aid curbs should be waived for the sake of "financial stability". He is arguing that "Brexit" (ah, there it is) has provoked a crisis that threatens that stability. EU officials do not agree, and have described Mr Renzi's exploitation of the Brexit issue as "cynical".

A politician stooping to the level of cynicism ? We're shocked .....

If the opinion polls had another very bad day on Sunday as the results of Spain's second general election in six months became clear,  it was a surprisingly good one for incumbent Prime Minister Mariano Rajoy and his conservative Popular party (PP). An outright majority for any party was never on the cards but against expectations the PP increased its share of the vote to 33% and collected 137 of the 350 parliamentary seats. Good news for Mr Rajoy certainly, and he is best-placed to attempt to form a government. He will now attempt to  cobble together an alliance with both the Socialist party and the centrist Ciudadanos party.

This will be far from easy, as both parties have in the past ruled out getting into bed with Mr Rajoy. Apart from their obvious political differences, Mr Rajoy's apparent ability to get up people's noses seems to have played a significant role in both parties taking that particular position. Mr Rajoy might be relying on two things if he hopes to change their minds : that politicians and electorate alike are tired of the political limbo and can't consider a third election ...... and that the Socialists in particular wish to cement their unexpected success in coming in ahead of the far-left Unidos Podemos alliance by allowing the PP to form a government.

Eurozone leaders would probably welcome Mr Rajoy's reinstatement, valuing him as a prudent pair of hands, economically-speaking. Even more welcome however will be the disappointing showing of Unidos Podemos.  Their electoral failure runs counter to the recent trend that has boosted support for populist policies, a trend that seemed to be endorsed, in it's watered-down, British way, by the pro-Brexit vote.

And so to the Fed, and the prospects for US rate rises. The poor US employment numbers had probably put paid to any real chance of a hike earlier this month anyway, but much was made of the possibility that the Fed might want to hang fire JUST IN CASE the unexpected should happen and the Brits should vote to leave the EU. Chairwoman Janet Yellen confirmed in her speech that such thoughts had played a part in the Fed's thinking and now with the markets in turmoil all will be thankful that they haven't got a US rate rise to deal with as well.

Globally, just about the most significant effect of the pro-Brexit vote (market-wise, that is) is not the weakness of sterling but the strength of the US Dollar, boosted by its status as a refuge in times of panic. It has risen against all major currencies except the Jap Yen (even more of a safe-haven) and on a trade-weighted basis is at a 3 month high.

When discussing the arguments for and against tightening policy, it is sometimes forgotten how much tightening results naturally from a strong currency without the need to raise rates. In other words, the strong dollar is doing the Fed's job for it and in all likelihood it signals that rates will be "lower for longer". It's strength reduces exports and profit margins for producers, and puts a dampener on inflation. The result : the probability of even one rate hike this year as indicated by Fed Funds futures ? Just 15%.

Brexit and its aftermath will not dictate the Fed's monetary policy, but no doubt it will have a big part to play in it ..... just like it will in everything else.