Nightmare of debt deflation stalks Europe
Wow, bad news for Europe
That is the true reason why they are worried. They could not care less for the thing that people are going to pay less for all - except that they are going to pay less taxes and they are going to pay less to their bosses - banks - in interest rates. All this "deflation crying" is a farce
You are missing trading opportunities:
- Free trading apps
- Over 8,000 signals for copying
- Economic news for exploring financial markets
Registration
Log in
You agree to website policy and terms of use
If you do not have an account, please register
Europe, bloody hell!”, as Sir Alex Ferguson, the former manager of Manchester United, might have put it had he ever chosen to swap the permanently febrile, money-driven world of football for the normally febrile, money-driven world of the financial markets. Recent disappointing growth and earnings data have underlined how fragile the European economy remains. It has, inevitably, forced a rethink by all those investors who have been enthusiastically driving equity prices up and bond prices down since the euro’s existential crisis in 2012.
It is not just the simmering crisis in Ukraine that has caused jitters. According to Bank of America Merrill Lynch, consensus earnings expectations for 2014 in Europe have fallen from 12 per cent at the start of the year to little more than 6 per cent now. They may fall further still. Start-of-year broker optimism on earnings is as timeless as the seasons, but there is no gainsaying the deterioration in the economic outlook that the latest miserable figures imply. Sanctions over Ukraine are a factor, but not the primary cause of this trend.
Against a background of generally low market volatility, the scale and breadth of the market setback in Europe is striking. Even the Dax has fallen more than 7 per cent peak to trough. With Germany reporting a contraction in gross domestic product in the second quarter, the yield on 10-year German Bunds has fallen below 1 per cent for the first time.
In this context, market expectations that the European Central Bank will (and should) come to the rescue with a programme of quantitative easing seem premature and complacent. Some form of QE by the ECB will come in due course, but will it be enough to pull Europe out of the debt deflation nightmare that seems to be on the cards? There are reasons to have doubts.
The most obvious one is that the ECB’s freedom to manoeuvre is much more limited than that of other central banks. Even in good times, it takes months to build a consensus for action among the key member states, and the issue of QE remains highly contentious, both as to its wisdom and its legality. Assuming that primary purchases of government bonds are ruled out, it is open to question whether there are sufficient assets that the ECB can legally buy to achieve the necessary market impact.
Second, it is clear that the ECB needs (and wants) to get its stress tests of Europe’s banks out of the way before going much beyond the monetary policy measures announced last month. To be credible, publication of the results in October needs to be followed by a period of market review and demonstrable improvements in balance sheets. A QE programme could create conflicts of interest with its bank supervisory role. That makes it virtually certain that, in the absence of some new market-driven crisis, the ECB will inevitably find itself “behind the curve” in implementing a QE programme.
More fundamental still is that any steps by the ECB to move into the breach will inevitably pull Europe towards greater de facto economic and fiscal integration at a time when the political dynamics are clearly pulling in the opposite direction. Political leaders have no appetite (and no mandate) for changing either the German constitution or negotiating a treaty change to ease the obstacles to large and decisive intervention by the ECB.
Finally, there is the problem that a programme of asset purchases might not do much more than buy some time. Whatever else the history of QE programmes has shown, it is evident that it does nothing in itself to generate economic growth. Only structural reform and appropriate fiscal measures can do that, and on that score, progress across the eurozone remains painfully slow.
It is true that the path of European market performance since 2012 has followed a familiar market-driven pattern. The relief rally that greeted ECB president Mario Draghi’s “whatever it takes” intervention in mid-2012 was followed a year later by a predictable surge in fund flows into European equities and periphery bonds, driven by the spreading and self-reinforcing belief that the crisis had been solved. That in turn became a momentum trade running into the new year. It has now stalled as investors wake up to the fact that the implied revival in economic and corporate fundamentals is failing to materialise.
Lurking behind these market gyrations lies a far more serious issue. Angela Merkel, the German chancellor, said at the height of the crisis two years ago that “if the euro fails, Europe also fails”. She has masterminded the policy of doing the minimum necessary to keep the single currency (and by extension the European dream of political and economic integration) alive, despite all the political obstacles. George Soros, the hedge fund billionaire who also has form in these matters, takes a profoundly different view. The danger now, he argues, is that “jettisoning the euro” may be necessary to save the EU itself.
While European equities fell 4 per cent from their high point in the latest market move, the MSCI eurozone index was down 10 per cent over the same period. Although oversold in the short term, the recent sentiment shift in the European financial markets is a reminder that Europe’s economic recovery remains intimately tied to the fate of its single currency. That ambitious project is far from resolved, just as most of us suspected two years ago.
source