by Don Alexander, MBA
Associate, RSD Solutions Inc.
The Euro rebound is stronger than anticipated as investors and central banks show an increased appetite for euro denominated paper as signs of a Greek debt crisis start to fade. The rise in oil prices and surge in central bank reserves has triggered the demand for currency diversification. The euro is one of the few safe currencies that can absorb the growth of reserves. As we have noted in our blogs of Feb. 26th and Feb. 15th, USD or Canadian dollar based investors may want to hedge potential euro exposure.
Analysts expect the demand for euro denominated assets to persist temporarily as oil prices remain elevated and central banks, especially in emerging markets, continue to diversify reserves. This temporary demand for euro denominated may receive temporary support from political tensions in the Middle East and the false sense that problems in the euro peripheral countries have been resolved. Longer-term, the risks to the euro remain to the downside as the sovereign debt crisis has evolved into a banking crisis and projected economic stagnation in Europe relative to the rest of the world.
Spreads on sovereign debt declined since the proposed settlement for Greece was reached. There is a link between the decline in bond spreads and the ECB announcement the creation of the long-term refinancing operations (LTROs). There is concern that banks will borrow from the ECB at low rates and buy sovereign bonds whose yields are higher, especially where banks are subject to local political pressure. Policymakers realize that one of the necessary conditions to stabilize financial markets was the need for an explicit guarantee (such as the ECB) for sovereign debt.
However, this move along with the other temporary financing facilities falls short of what is needed. Greece and Portugal will not be able to grow with their existing debt burdens. This could result in contagion spreading to Italy and elsewhere. European growth is projected to be flat to negative for 2012 and only a modest in 2013, especially with significant budget cuts.
The temporary financing could make things more dangerous. Any wave of sovereign defaults would create problems for the ECB as nearly euro one trillion in sovereign debt is due for rollover in the next 12 months. The sale of overseas assets by European financial institutions to bolster capital and continued reduction of sovereign exposure by private investors could add to euro pressure. European politicians have failed to address any of the underlying long-term structural issues facing euro such as monitoring and implementing policies deficit reduction among member states.
No comments:
Post a Comment