The euro, brinkmanship and market distress
0In the wake of the German bond auction results, we can argue that whilst breakup of the Euro is by no means a foregone conclusion, extraordinary things will almost certainly need to happen – and to put a
time limit to this, probably by mid-January – to prevent the progressive closure of all the Euroland sovereign bond markets, potentially accompanied by escalating runs on even the strongest banks.
That may sound overdramatic, but it reflects the inexorable logic of investors realizing that in the current circumstances, they simply cannot be sure what exactly they are holding or buying in the Euroland sovereign bond markets.
In the short run, this cannot be fixed by the ECB or by new governments in Greece, Italy or Spain: it’s about markets needing credible signals on the shape of fiscal and political union long before final treaty changes can take place.
This must signal the death of “muddle-through” (quoting Merkel as reported) with market pressures effectively forcing France and Germany to strike a momentous deal on fiscal union much sooner than currently seems possible, or than either would like. Then and only then is it likely that the ECB will agree to provide the financial support to prevent systemic collapse.
The debate on fiscal union heats up from this week, with the Commission’s paper on options for mutually guaranteed “Eurobonds”, to be followed by the summit on 9th December and the expected speech by President Sarkozy to the French nation scheduled for the 20th anniversary of the Maastricht Treaty (11th December).
Such public utterances may provide some comfort, but we must expect more wrenching brinkmanship and market turmoil, similar to the game of chicken played out over the US debt ceiling this summer, or the messy passage of TARP in 2008.
It is interesting and discomforting that the pressure on Italian and Spanish bond yields may worsen just as their governments make progress, and higher French and German bond yields look quite possible. Moreover, this could happen even as the ECB moves more aggressively to lower rates and introduce
extra measures to provide banks with longer-term funding.
Against this backcloth, and perverse as this may seem, US bond yields may fall, or at least not rise, despite the possibility of improving US growth data. Equally, global equity markets could follow a version of the sell off seen in Q1 2009 as the debate intensifies and until the outlook is resolved. This may well turn out to be an important part of the tapestry in that it may be that visible market distress that is the source of necessary pressure to force political agreement.
Meanwhile, the sensible focus for investors is on quality, reliability and sustainability of revenues, cash flows and balance sheets.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
