Finance Ministers across the EU must have been weeping yesterday.
Having spent nigh on two weeks negotiating a bailout package with the Irish government hoping to increase investor confidence in the EU and prevent panic spreading to Portugal and Spain, the markets momentarily rallied. Yes! The announcement of an €83 rescue deal with the Irish had assured the markets that Ireland could become solvent with its debt secured by the EU.
But no. Not long after the package was announced credit default swap rates (the insurance prices investors pay to protect them in case the EU banks collapse) rose not only in debt-laden nations such as Portugal and Italy but Germany too. The Irish bailout in fact had the opposite effect than intended by EU-IMF officials and increased pessimistic sentiment toward the euro.
So what happened yesterday?
The problem is this: Investors increasingly realise that nations including Portugal and Spain face near-identical problems to the Irish, making EU bailouts for these nations look more inevitable. Political leaders in Portugal and Spain can posture but the numbers don’t lie: Spain’s total debt is 220% of national GDP at the moment for instance.
Hence if bailout packages for these EU members are inevitable the question is no longer whether the EU-IMF can rescue them, but whether core members (particularly Germany) have the political commitment to the EU project to do so.
Germany for instance (the powerhouse of Europe) must take a decision: whether to secure billions of euros of debt for members of the EU or simply let the project collapse. The former option is unpopular within Germany (understandably German citizens don’t like the idea of taking on colossal debt because other nations can’t manage their finances.) However officials within Germany as well as France seem extremely committed to the EU project.
This means in consequence that investors have shifted their attention from EU periphery members to the EU as a whole. The debt crisis no longer concerns individual countries but has become a test of the commitment of the project’s founding members. Hence the rise in German credit default swap rates, though Germany is comparatively solvent.
So until the German government puts its cards on the table – perhaps by pre-emptively buying the debt of less solvent EU members before the crisis explodes – investors are nervous about the EU. In consequence sentiment toward the euro is less than optimistic at the moment.
By comparison the dollar is performing strongly at the moment against both sterling and the euro. This is because of reduced risk appetite in the short term: investors treat the dollar as a safe haven currency in times of political turmoil.
Coming up later? Today the latest German unemployment figures are released, and are expected to show improvement for the nineteenth consecutive month. This might traditionally improve sentiment toward the euro but the debt crisis could dominate the markets instead.
[Update: German unemployment figures have been released and shown a nine thousand person drop.]
In addition the latest consumer confidence numbers are released in the US. These are expected to show increased optimism among US consumers, and could further strengthen the dollar.
By Peter Lavelle with currency exchange specialists Pure FX.