Thursday, February 10, 2011

Euro-Zone Crisis Viewer’s Guide

Europe’s debt problems are on everyone’s lips again thanks to soaring bond yields in weaker euro-bloc countries like Ireland. Here’s a crib sheet on what to watch this week.

* The indefatigable euro. The value of Europe’s common currency has somehow shot higher despite rising tensions in debt-addled Ireland, Portugal and Greece. Last week, the euro jumped to around $1.43–a nine-month high–after the U.S. Federal Reserve goosed the financial markets by announcing $600 billion in additional monetary stimulus. With the Fed’s long-anticipated decision now in the rear-view mirror, analysts are warning that attention could return to Europe’s sovereign-debt problems, hurting the euro’s exchange rate with the dollar and pound. This may already have started: A glowing U.S. jobs report on Friday muffled the euro, and the currency is struggling again Monday on a wave of euro-zone debt concerns, dropping 0.7% to $1.3932. Traders seem to be looking downwards: Even though we got a rare piece of good news from Greece -– Prime Minister George Papandreou didn’t end up calling snap elections like some feared –- the euro isn’t getting much help. (Greece’s stock market is, though – it’s up 2.5%.)

*Irish and Portuguese bond yields. These can only go up these days it seems. If Ireland tried to borrow money from investors for 10 years, it would probably have to pay an interest rate of 7.83%, a record 5.43 percentage-point premium over Germany’s borrowing rate. Unlike Greece earlier this year, Ireland has enough cash in its coffers to avoid going to investors for a while, and it also doesn’t have a major bond repayment due until November of next year. But this kind of 10-year borrowing rate is unsustainable, fueling fears the country will need to use the European Union’s emergency-rescue mechanism. “The key to success or failure is … to control funding costs,” says Arnaud Mares, a former credit rater and now an analyst at Morgan Stanley, in a report Monday. “If the Greek or Irish government had to pay current market yields on a sustained basis, it would be less plausible that debt stabilization would occur.” At 8 p.m. in Dublin Monday, Irish Finance Minister Brian Lenihan and top European economics official Olli Rehn -– who’s visiting there to help Ireland hammer out deficit-cutting plans –- will try to calm the market with a press conference.

* Politics, politics, politics. Investors are paying unusually close attention to political wrangling in Greece, Ireland and Portugal since this can determine whether countries stick to deficit-cutting plans. Greece’s ruling Socialist party survived a key test of its popularity in local elections Sunday, but one thing spooking the market on Monday is news from Ireland: A member of Ireland’s Green party, the junior partner in the country’s ruling coalition government, is saying Ireland shouldn’t cut public-sector pensions in its upcoming Dec. 7 budget for next year. Most observers expect Ireland’s political parties to come together to pass the budget, but jostling before the date is likely to keep investors on edge. Irish Prime Minister Brian Cowen’s coalition government has only a razor-thin three-seat majority in Parliament. A big political foul-up could lead to new elections if the budget doesn’t pass.

* Three more things. It’s also worth watching Portugal’s bond sale on Wednesday for signs of trouble.? A failed bond auction or a major jump in borrowing costs could rattle investors, though China just promised to help the indebted country, possibly with purchases of government bonds. China has made similar cooing noises to Greece and Spain. Later Monday, we’re going to find out whether the European Central Bank had to intervene in Europe’s bond markets last week by buying bonds to push yields down. The ECB hasn’t done that for several weeks now, so fresh purchases, even if they’re very small, would be another bad sign –- though it’s also possible that bond yields are jumping because the ECB is not buying bonds. Last but not least, we’ve got gross domestic product figures coming out for the euro-zone on Friday, with Germany, of course, expected to lead the pack and Spain expected to dawdle. Members of the euro zone are slashing their budgets to cut their huge deficits, but there’s only so much that ripping up budgets can do. At some point, to get your debt burden under control, you need good old growth, which brings in tax revenue.

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