I’m starting to think there’s a bit of a conspiracy going on in the global markets just now.
Europe and the US are the key players. Every time investors get too worried about the problems occurring on one side of the Atlantic, the authorities on the other side stick their heads up and shout: “Hey, forget them! We’re in much worse shape!”
As economics professor Michael Spence puts it on Project-Syndicate.org, “capital markets have become schizophrenic, with investment rushing back and forth across the Atlantic in response to contagion risk in Europe and quantitative easing in the United States.”
This week, the big story has been the spike in US Treasury bond yields. There have also been rumblings of fear over how US cities are going to fund themselves in the near future.
But now it looks as though the worry pendulum might be about to swing back to Europe once more…
Everyone’s worrying about Treasuries
The story of the week so far has been the strong rise in US Treasury yields (ie, bond prices have fallen). This has been inspired mainly by the news of further tax cuts in the US.
In other words, borrowing costs for the US government have gone up. That’s not necessarily all bad news. One reason for the rise in yields may be that investors are more optimistic on the outlook for the US economy. As a result, they’re not as interested in holding on to such low-yielding assets as Treasuries.
Of course, the downside is that rising borrowing costs aren’t exactly what the Federal Reserve was aiming for when it announced more quantitative easing. Indeed, it intended the exact opposite. Ben Bernanke had said he was aiming to cut long-term interest rates, not drive them higher.
Also, investor optimism might not be the whole story. Investors are also worried about the fact that neither the Fed nor the US government shows any signs of ever adopting a sustainable monetary or fiscal policy. You can read more about the end of the great bond bull market in my colleague David Stevenson’s article on the topic from last Friday: Is this the end of the great bond bull market?.
However, just as everyone’s fretting about Treasuries, it looks as though the market’s attention may be about to switch back to the sticky problem of Europe.
Why Spain is the big worry for the eurozone
The euro slid hard against the dollar yesterday. The catalyst was a warning from credit rating agency Moody’s that Spain’s credit rating might be downgraded. Spain is the big worry for the eurozone. Ireland and Greece were nasty blips, but they could be coped with. Portugal falls into the same category.
But a bail-out for Spain would be harder to swallow. To sort that one out, the leaders of the eurozone would have to come to a much more long-term solution to the region’s debt problems than the current sticking plasters.
Spain has three main batches of debt to worry about, says Robert Peston on his BBC blog. First, the central government “has to raise and refinance a very substantial sum in 2011, some €170bn.” Foreign investors as you’ll have noticed, aren’t keen on eurozone debt just now. And the trouble is that Spain’s government has historically relied on overseas buyers “for about 50% of all the money it raises.” On top of that, there are loans from the regions – €30bn worth – that need to be rolled over next year. And another €90bn of borrowing by the banks.
That’s all bad enough. But it could get worse. Moody’s is worried that banks might have to raise more capital, which would probably have to come from the Spanish government. And there’s also the danger that austerity measures aren’t being imposed strictly enough. In all, Spain could end up needing to raise a total of €365bn, or 34% of its GDP next year. “To put it another way,” says Peston, “2011 will be the year when the financial credibility of Spain – and by extension the eurozone as a whole – is likely to receive its severest test.”
What does all this mean for the euro?
I was discussing this with a colleague the other day. It’s impossible to say precisely what will happen to the single currency. There are pretty strong forces lining up on either side of this battle.
On the one hand, there are national interests. Voters in Germany, for example, don’t like the idea of bailing out voters in other countries. And voters in Ireland are growing increasingly angry that their economy has been crippled by the costs of bailing out their own banks. So a revolt by voters in any number of countries could easily lead to more pressure for some sort of split.
And yet, a lot of time, energy and money has been invested in keeping the euro together. The same Germans who don’t like the idea of ‘bailing out’ other countries also understand that the euro has been a boon for their exporters, and don’t see the currency as the problem. And Ireland loved being part of Europe in the good days, and still does – the popular anger is against the banks, not the single currency.
So all we can say with any certainty is that the euro faces very uncertain times. And while its future is in doubt, there will be lots of volatility, as investors swing from optimism to pessimism with every new initiative announced by Europe’s leaders.
How do you profit from that? Currency trading isn’t a ‘buy and hold’ game. It’s risky and it’s pure speculation. There’s nothing wrong with that, but you have to know what you’re doing. A good place to start is with our spread betting blogger, John Burford. He has been writing regularly about his tactics for trading the euro against both the pound and the dollar.
Even if you’re not keen to try your hand at spread betting, John’s spread betting blogs are well worth reading for anyone at all interested in investing, or investor psychology. If you’d like to sign up for his free MoneyWeek Trader email, which is launching shortly, then just let us know here.
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