2013 is looking increasingly like a year one can split into three very distinct thirds. The first third took us up to May, encompassing the Cypriot crisis and the inconclusive Italian election, sending risk markets into tail-spins and yields lower, and finishing when Ben Bernanke first mentioned the possibility that the Fed may 'taper' or reduce its bond-buying quantitative easing program.
After Bernanke's comments, the second third was characterized by a sharp increase in US Treasury and Mortgage Backed Security yields, with the 10-year Treasury Note yield rising from 1.63% in May to a peak of 3% in early September, just before the release of slightly tepid data on US unemployment.
Finally, we have entered the last third of the year, which began with a bang, when the Fed confounded every single 'expert', including this one, by failing to 'taper' at its September FOMC meeting, citing uncertainties over the pace of recovery and possible headwinds from upcoming US debt ceiling and budget debates. The decision had been closely preceded by the withdrawal of Larry Summers from the shortlist to become the next Chairman of the Fed, when Bernanke retires next year. Notice I don't say surprise withdrawal, as I for one had always suspected that Summers is such a divisive figure, provoking such entrenched support or opprobrium, that his candidacy was unlikely to survive the nomination process and Senate debate. So it became expedient for President Obama to compromise by ditching his preferred candidate.
This is perhaps the latest in a string of compromise solutions that have become the leitmotif for 2013 - the Cypriot crisis was 'solved' through the politically acceptable compromise of denuding rich Russians of their deposits (the unspoken justification being the suspect origins of their money), the confused political landscape in Italy didn't descend into anarchy, and it was in none of the parties' interest to provoke a snap repeat of February's general election, although recently tensions have escalated again, as Berlusconi's MP's threaten resignation, as they try to put pressure on PM Letta over the Berlusconi's possible disbarment from the Senate. It even became convenient Realpolitik for the US to compromise with Russia over Syria, with war crimes being effectively brushed under the carpet.
This final third of the year also seems destined to be all about give and take, especially following the German federal election result.
Chancellor Merkel's conservative CDU/CSU secured 41.5% of the vote, more than 40% for the first time since 1994, a landslide victory and a ringing endorsement of her skillful guidance during the recent Euro crisis years, but her current coalition partners, the FDP, failed to reach the 5% threshold for parliamentary representation, and so did the anti-Euro AfD party. This all implies that the CDU/CSU will have to try and repeat its not altogether happy experience of alliance with the centre-left SPD.
Where does this leave the Euro? Even more secure. Economic theory would suggest that to survive, a monetary union must also be a fiscal union. Merkel and other mainstream German politicians all realise this and also know they probably have five years, at the most, to make it happen, or at least to set the Euro on an a certain path towards it.
A precursor to the full fiscal union would be the issuance of joint and several Eurobonds, which would immediately remove the threat of further market-induced trauma in peripheral bond markets.
Sigmar Gabriel, Chairman of the SPD, recently told Berliner Zeitung that his party was prepared to accept collective debt liability - the quid pro quo demanded of the peripheral states being stricter oversight of their budgets, from Brussels. He acknowledged that this would require a change in the German constitution and probably a referendum. Crucially, a Grand Coalition would have the requisite majority in the Bundesrat to achieve this.
Thus far, Markel has refused to countenance Eurobonds. Given how far down the 'Euro path' she has cautiously and judiciously lead the German people, it hardly seems beyond the realms of plausibility that she will eventually compromise and agree to Eurobonds. Softly, softly she will win the voters over to this view.
In return for her agreement on this, the SPF will mollify some of its more left-wing domestic agenda on taxation and the minimum wage. She may bend somewhat more on demands for austerity in the periphery. Compromise will abound.Suggest a correction