By Kathleen Brooks. The opinions expressed are her own.
Markets thrive on certainty. Anything that smacks of uncertainty, fence-sitting or indecision will lead to market turbulence, as investors punish those who don’t tell them how it is.
This is exactly what we are seeing in Europe right now. The markets are losing patience with the EU’s inability to come up with a credible plan to fight the sovereign debt crisis and that is why it is escalating at an alarming rate.
In general, investors in credit markets are a canny bunch. Bond spreads between Germany and Greece, Ireland, Portugal, Spain and Italy have already blown out, but in recent days spreads between Germany and France, Belgium and even Austria have increased to their widest level for more than two years.
So what does this all mean? In short it suggests that bond investors are going off Europe, even those members who were previously considered safe are no longer out of harm’s way. The credit markets are turning against the political make-up of the currency bloc and until concrete changes are made to the structure of the euro zone the pressure on European credit markets is unlikely to abate.
The various branches of authority in the Eurozone seem to lurch from one crisis to another. Because there is no central voice or authority you end up with a cacophony of voices talking at odds to each other that confuses the markets.
For example, Germany and the ECB continue to play out their differences in public on whether private investors in Greek debt should take a loss. A new low was when the EU President confirmed an emergency summit would be held last Friday, which some member states didn’t even know about.
The effect of this is that sentiment towards European assets is being eroded. The Eurostoxx 50, the pan-European equity index, is nearly 12 percent lower than it was in February; in contrast the S&P 500 is down only 2 percent.
If investors punish indecision, they reward leadership. This is why stocks rallied during Ben Bernanke’s recent semi-annual testimony to Congress. Bernanke was extremely clear to U.S. politicians that “the pace of expansion so far this year has been modest.” He told them the ugly truth including the state of the precious U.S. consumer: “Households report that they have little confidence in the durability of the recovery and about their own income prospects.”
Bernanke isn’t sugar coating anything. Even the impact of QE2 was laid out straight: he told law makers that it lowered long-term interest rates by a modest 10-30 basis points, and contributed to the creation of about 30,000 new jobs per month.
However, rather than cause panic in the markets stocks actually jumped and the S&P 500 climbed nearly 1 percent on the back of Bernanke’s comments. But why was this?
Firstly, the chairman of the Federal Reserve clearly understands what is going on in the U.S. economy. Next, he has a plan. Bernanke said the Fed stood ready to provide more stimulus if the U.S. economy was to take a turn for the worse. It will be watching the data closely and if there is no improvement then it will bring out more ammunition from its war chest and fight to bring down the employment rate.
To the investor it is clear: the Federal Reserve will take hold of a situation and has a plan to deal with the worst-case scenario. In sharp contrast, European authorities have no plan to deal with Greece et al, and it can’t even organise a meeting to discuss the issue.
This is why credit investors and now equity markets are punishing Europe. Without a plan there can be no faith, and no faith means lower asset markets.
Image — Chairman of the Federal Reserve Ben Bernanke listens while testifying before the Senate Banking, Housing and Urban Affairs Committee about “The Semiannual Monetary Policy Report to the Congress” on Capitol Hill in Washington, July 14, 2011. REUTERS/Larry Downing
