HURRAH! All the tricky issues are out of the way. A second round of quantitative easing from the US Federal Reserve – done. The US jobless numbers – done. President Barack Obama’s mid term elections – done. And so what does all this mean for the markets? All together now… it is time to start worrying about peripheral Europe again. Isn’t life simple? Spreads between Irish 10-year bonds and German 10-year bunds have been driven to their widest levels ever.
While some believe that not a whole lot has changed over the past few weeks for smaller European countries, the evidence suggests the contrary.
I sat down with the man many know best as Dr Doom, Nouriel Roubini, co-founder and chairman of Roubini Global Economics, and he told me he thinks there have been two market triggers for spreads widening. First, the signal coming from the French-German agreement that there will be a resolution mechanism for sovereigns to create an orderly debt restructuring mechanism (which means that there’s a larger probability that we’ll eventually get a debt reduction in places like Greece and Portugal). Second, Ireland’s extension of debt guarantees to the financial system, which implies that they’re transferring ever more of the losses from the banking system onto the government’s balance sheet. Eventually, according to Roubini, sovereigns won’t be able to cope with this massive burden.
Roubini argues that the ECB is just making the problem worse. He thinks that in a situation where there is such a huge fiscal consolidation going on, the ECB should be providing more liquidity to the financial system – in this case in the form of further quantitative easing and by buying the debt of many of these troubled sovereigns.
In Roubini’s view, monetary policy in the Eurozone is too tight, and it only gets worse when you factor in currency moves. Germany can live with a euro of $1.40/$1.50 as it is so competitive, but peripheral Europe actually needs a euro closer to parity against the greenback. This is damaging the recovery in large parts of Europe – and if there is no growth, then the sovereign and banking problems will only become worse.
The good part is that the Fed’s latest round of stimulus is equivalent to a 0.75 per cent interest rate cut. The bad part? Most of that was already priced in by the markets. All in all, while we have reduced the chances of a global double dip recession or near term deflation, Europe faces a very sticky period indeed.
Louisa Bojesen co-anchors European Closing Bell weekdays on CNBC.