Friday, January 13, 2012

Euro Fatigue

For the second half of 2011, nearly all market discussions began and ended with some sort of comment about the euro.

Now, however, even though the euro situation is far from "solved", it seems that the collective market has turned its attention to other discussions.

Writing in yesterday's Financial Times, columnist James Mackintosh pointed out that the conventional view in the investment world is, "America good, Europe bad.  The US economy is surprisingly strong, while Europe is perhaps already in recession." But, as Mr. Mackintosh points out:

No wonder investors prefer the US, with the S&P 500 up 15 per cent, including dividends, since Europe's autumn bottom.

But wait! Eurozone shares, including dividends, are up 15 per cent too. Charts of the two are almost indistinguishable.

However, while the equity market may be weary of worrying about euro, the crisis is far from over, at least as far as the credit markets are concerned.

Earlier this week, Switzerland was able to sell 15 year bonds with a yield of less than 1%.  US Treasury yields continue to move lower as well, as worried investors flock to our bond market in favor of security.  Here's the story from yesterday's Bloomberg:

The Treasury sold $21 billion of 10- year notes at a record low yield as speculation France may lose its top credit rating amid Europe’s debt crisis bolstered the refuge appeal of U.S. government securities. 

The bonds drew a yield of 1.90 percent, compared with a forecast of 1.928 percent in a Bloomberg News survey of nine of the Federal Reserve’s 21 primary dealers. The bid-to-coverratio, which gauges demand by comparing total bids with the amount of debt offered, was 3.29, versus an average of 3.11 for the past 10 auctions.

Then there are concerns about Hungary, another euro block country in serious fiscal straits.  Here's an excerpt from New York Times columnist Paul Krugman's blog:

The markets have issued a judgment on Hungary as well. Last week, the forint reached an all-time low against the euro and Hungary was unable to sell short-term government bonds in the markets. Its 10-year bonds must promise a nearly 10% yield, unsustainable over the long haul. . After Europe showed yesterday that it was ready to pressure Hungary into complying with its demands, Hungary’s short-term bonds must now promise nearly the same yield as its long-term bonds, but that is an improvement over not being able to generate any acceptable bids for short-term debt at all. .

Oh, and what about that money that the European Central Bank gave the large European banks at the end of last year to avoid a credit crunch?

Well, it turns out that the banks just took the funds and stuffed them into reserves.  None of them apparently have any interest in resuming lending activities to bolster the European economy:

Banks are hoarding the European Central Bank’s record 489 billion-euro ($625 billion) injection into the banking system, thwarting attempts by policy makers to avert a credit crunch in the region. 

Almost all of the money loaned to 523 euro-area lenders last month wound up back on deposit at the Frankfurt-based central bank instead of pouring into the financial system, according to estimates by Barclays Capital based on ECB data. Banks will use most of the money from the three-year loans to meet their refinancing needs for this year and next, analysts at Morgan Stanley and Royal Bank of Scotland Group Plc estimate.

Now, there are a few hopeful signs:  Spanish and Italian government bond yields, for example, have moved sharply lower after successful bond auctions.

However, the fundamental problems facing the euro zone have not disappeared, despite the fervent wish that they will.

Put another way, the end game has not yet been played.