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Posts Tagged ‘Eurozone’

Germany vs. France Not Just Being Played on the Pitch

June 17th, 2010 Michael McDonough Comments off

The spread between France’s and Germany’s 10y Government bonds remain near levels not seen since the collapse of Lehman as France takes on tough fiscal tightening.  Since the onset of the European debt crisis France and German yields have benefitted from worried investors moving funds away from economically weak Eurozone peripheries to the regions ’stable’ AAA rated credits.  However, after being blindsided by Europe’s debt crisis investors are developing a new sense of risk, which doesn’t bode well for France’s lackluster history of correcting past deficits, especially while its current budget deficit approaching 8% of GDP.    This has given Germany an edge in investors’ flight to quality. France has already undertaken remedial measures to rein in the deficit, including raising the retirement age to 62 from 60, prompting  protests from the country’s socialist party and labor unions.  France will likely struggle with its ability to rapidly implement the necessary austerity policies, with any significant slippage, or success, revealing itself in the country’s spread to equivalent German government bonds.

Source: Bloomberg

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Spreads in Europe on Track to Test Pre-Bailout Levels

June 7th, 2010 Michael McDonough Comments off

The aggregated spreads of Europe’s weakest peripheries plus Belgium are on track to test their pre-bailout levels, as investors question whether or not a default will become necessary and what contagion effects it might have.  The biggest concern is that a default could lead to a Lehman like effect halting liquidity as banks and investors question each other’s exposure to the defaulted debt potentially leading to a significant funding issue for seemingly non-effected nations.  On this note, the German backed-bailout was not just a rescue of its profligate neighbors, but also its domestic banks, which are said to have significant exposure to the bonds in question.  In any case, trader sentiment toward the Euro is likely to remain weak as spreads drift higher for economically weak nations as the fine balance between effective fiscal austerity and growth is hopefully discovered. 

 Aggregate 10Y Government Bond Spreads Over Germany:

Source: Bloomberg

As an aside, over the past week Belgium yields have experienced the largest increment of the 20 European nations I track, which should continue to be monitored.  Belgium has one of the largest debt to GDP ratios in the region, a relatively weak fiscal deficit, and regional and political strife.  As the situation in Europe deteriorates, investors will likely continue focusing on Belgium, a trend that can already be seen through the past week’s spike in yields.  Prior to now investors had given the credit a pass partially due to a history of positive primary surpluses and its historical precedent of reining in wavering finances.  Belgium’s debt to GDP ratio is expected to climb to over 100% of GDP by the end of this year.  

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Euro Zone Countries Breached EU Fiscal Limits 57% of the Time (Bloomberg)

May 25th, 2010 Michael McDonough Comments off

http://www.bloomberg.com/insight/euro-breach.html

Here is an interactive graphic from Bloomberg highlighting the divergence of the Euro-Zone from their own financial criteria since the currency was introduced.

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Europhoria Already Wanes…

May 10th, 2010 Michael McDonough Comments off

Since the announcement of Europe’s unprecedented rescue package late last night, the Euro rallied to as high as almost 1.31/USD off of a low of 1.2529 on May 6th.  However, as the dust settles from Europe‘s nuclear option to address the continents widening debt crisis, lingering risks are reemerging as the Euro shows signs of weakness falling to 1.2780.  It’s akin to a classic monster movie where the government—out of options—decides to drop the ‘A-bomb’ as a last ditch effort to destroy the monster; as everyone begins to celebrate at the monster’s demise, hints of movement are noticed in the lingering debris cloud.  These movies typically end with some sort of mundane or natural force ending the monster’s rampage, and that might be what’s necessary for the European debt crisis.  While Europe’s bailout package may have weakened the monster it will take long-term fundamental change to truly end the crisis. 

The European experiment created a chimera that all EU nations were created equal, permitting member nations, despite their own domestic woes, to borrow far beyond their means, at irrationally low rates.    As reality is exposed for the European periphery, bailout or not, solvency cannot be guaranteed as tough, yet necessary, fiscal austerity could lead to wide-spread protests, and in a worst case scenario a double-dip recession for the continent.  The Euro’s late-in-the-day weakness is likely the first sign that investors have begun to see movement in the lingering cloud.

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A Crossroad for the Eurozone’s Survival

May 9th, 2010 Michael McDonough Comments off

Europe’s rapidly escalating out-of-control debt crisis has brought about a rare occurrence, solidarity amongst its members; an elusive attribute in the European experiment.   Eurozone members, who have worked tirelessly over the weekend, appear to have agreed on creating a $645bn loan package to help defend its currency and stymie fears of Greek contagion to other countries.  It is still too early to tell whether or not Europe’s new found cooperation will be enough to restore investor confidence, but the Euro has regained some ground in Asian trading.  The true test will come in its ability to bring down skyrocketing yields for Portuguese and Spanish debt, which has come under the microscope of investors due to each countries’ weak fundamentals.  Portugal’s close mirroring of Greece just prior to that country’s breakdown may have been a major catalyst to the creation of this unprecedented loan package—along with a free falling euro.

If this package fails to bring down yields for Spanish or Portuguese debt or stabilize the Euro this situation will very quickly escalate out of control with the potential of tearing apart the Eurozone.  Many already believe the best solution for Greece with but to withdraw from the EU, and return to the Drachma, which only a few months ago would have been an unspeakable idea.  However, historically these types of programs tend to work, or at least stabilize the situation and buy more time for a more permanent solution if necessary.  Nevertheless, a bigger risk may lie ahead for Europe in the form of a double dip recession brought on by austere fiscal policies necessary to repair most member nations ailing budgets.  The EU’s weakest members, commonly referred to as the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) could find it extremely difficult to survive another recession.  Think about someone who has maxed out all of their credit cards, and is about to take a large pay-cut at work.  The only difference here is these countries are indebted to more than just a few credit card companies…

The next twelve hours will be critical for Europe, however, investors mustn’t forget about the next 12 days or 12 months either as this package could prove to be a Band-Aid for a much deeper wound.

Early comments from Paul Krugman raise some good points, but aren’t promising for either Portugal or the rescue package. But, I think the precipitous drop in the euro is indicative of plunging confidence in the region, and both aspects need to be addressed simultaneously.

“I’m not encouraged by the remarks of some of the leaders, who keep talking about protecting the euro as if speculation against the currency were the problem. Actually, a weak euro helps Europe. Speculation against the debt of weak nations is another matter; will they have any real answer to that problem?”  -Paul Krugman

Krugman’s Blog

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