I had a nagging feeling all last week that there was something missing from my usual routine.
Then on Friday night it hit me. I’d managed to go a whole week without feeling the need to write about the eurozone.
It was of course, too good to last.
Markets across the globe tanked on Friday, with fears over Spain the primary driver.
So what’s gone wrong this time?
The bond markets have almost closed to Spain
Spain’s situation is rapidly deteriorating. On Friday, Spain’s benchmark index, the IBEX, dived by nearly 6%. The euro, meanwhile, slid sharply. It’s getting close to a two-year low against the dollar.
But the real problem is Spain’s borrowing costs.
Investors are concerned that the ‘no-strings’ deal to give its banks €100bn in aid from the European bail-out fund in fact had plenty of strings attached. In other words, the ‘doom loop’ between sovereign and banking sector hasn’t been decisively broken.
If Spain still has to stand behind its broken banking sector, then that means no one in their right minds would invest in its bonds. Because if the Spanish government takes bail-out money from the European authorities, then existing private sector creditors will be pushed down the queue.
Yes, I know that the Europeans said at the last summit that this wouldn’t happen. But if you believe that then you’re probably in the market for Spanish timeshare flats too.
So a disappointing bond auction on Thursday spooked buyers. And it only got worse on Friday, when the Valencia region asked for emergency assistance from the central government. On top of that, Spain now expects to be in recession until 2014.
Spanish ten-year borrowing costs spiked to a near-record high for the euro era, rising to just below 7.3%. And as I’m writing this, an alert has just flashed up on my screen telling me that ten-year yields are now at record highs, spiking above 7.5% this morning.
But the real problem is the short-term borrowing costs. Five-year borrowing costs hit 6.88%, a new record.
This matters. Up until now, even if it was too expensive to borrow over ten years, Spain could have borrowed over shorter periods at lower rates. That way it could buy itself time until some sort of longer-term solution had been reached.
Now, as one City expert put it: “To all intents and purposes, Spain is now frozen out of the bond markets”.
What happens now?
That’s scary. Money is fleeing Spain (and the other ‘troubled’ states). Bond yields in many ‘safe’ countries are turning negative. In other words, people are willing to accept a small loss – even before taking inflation into account – to lend to these countries.
This isn’t as odd as it seems, by the way. If you have a large quantity of money, and all you care about is the return of your capital, rather than the return on your capital, then there aren’t many places to put it.
You can’t trust a bank: deposit insurance only goes so far, and what if you can’t rely on the government who backs it? As for corporations – they can go bust, or be targeted by governments.
All that really leaves is governments that won’t go bankrupt. So you park your money with the likes of Germany and Switzerland. Or maybe even the UK: yes, sterling might plunge if there’s too much Spain’s borrowing costs, but right now, you’ll take that risk against the danger of the euro imploding.
Effectively, you are paying a premium for security. And in this kind of environment, for a lot of people, security looks worth paying for.
The big question is: what happens next?
As we’ve often said, the eurozone crisis is about politics, not economics. People – the voters – still want the euro. To realise that, you just need to look at the comeback campaign of Italy’s Silvio Berlusconi. The FT quotes Italy’s former defence and foreign minister, Antonio Martino: “Berlusconi has been cured of his anti-euro ideas. He is convinced that going back to the lira is not a quick fix”.
As political opportunists go, Berlusconi is up there with our own unwelcome blast from the past, Tony Blair. So the fact that he’s changed his take on the euro suggests that he knows it’s not a vote-winner.
The trouble with the euro is that every pathway is painful. That makes it hard to see the path that politicians will take – which is always the path of least resistance.
But letting Spain go bust is not that path. If Spain goes, the euro can’t survive. And that’s not yet an option for the eurozone elites.
It still seems to me that the likeliest way forward (although this is not a high conviction call) is that Greece gets thrown out. Using the casting aside of Greece as cover, the rest of the eurozone – Germany in particular – can then push through a deal to unite the remaining members more closely.
How to pick up a eurozone bargain
However, I don’t think you have to bet on a specific outcome. The fact is that many European markets are cheap now – and they’ve just got cheaper. I’ve added a small dash of Italy to my own portfolio, and I think I’ll continue drip-feeding some money in there. In the long run, I think it’ll pay off, regardless of what happens.
If you’d rather wait for more certainty, then in the current issue of MoneyWeek magazine, bear market expert Russell Napier tells Merryn Somerset Webb what he thinks the ‘buying signal’ for Europe will be. You can read the whole interview here: How we can fix Britain’s banking system (if you’re not already a subscriber, you can subscribe to MoneyWeek magazine.)
Also in the magazine this week, for the more daring, my colleague Phil Oakley chooses the three high-yielding European stocks he reckons are the best bargains to pick out of the eurozone rubble.
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