Euro End of Days
Credit Suisse Chief Global Strategist Jonathan Wilmot believes we have entered the last days of the euro as we currently know it. Wilmot says that doesn’t make a break-up very likely, but it does mean some extraordinary things will almost certainly need to happen – probably by mid-January – to prevent the progressive closure of all the Eurozone sovereign bond markets, potentially accompanied by escalating runs on even the strongest banks.
Wilmot says this may sound overdramatic, but it reflects the inexorable logic of investors realizing that – as things currently stand – they simply cannot be sure what exactly they are holding or buying in the Eurozone sovereign bond markets. In the short run, Wilmot says this cannot be fixed by the ECB or by new governments in Greece, Italy or Spain; it’s about markets needing credible signals on the shape of fiscal and political union long before final treaty changes can take place.
Wilmot suspects this spells the death of “muddle-through” as market pressures effectively force France and Germany to strike a momentous deal on fiscal union much sooner than currently seems possible, or than either would like. Then and only then does Wilmot think the ECB will agree to provide the finance bridge needed to prevent systemic collapse. Wilmot believes the debate on fiscal union will really heat up from this week when the Commission publishes a new paper on three different options for mutually guaranteed "Eurobonds," continue at the summit on December 9 and through a key speech by President Sarkozy to the French nation scheduled for the 20th anniversary of the Maastricht Treaty on December 11.
The process of reaching agreement will involve some high stakes brinkmanship and market turmoil in subsequent weeks. Not unlike the U.S. debt ceiling debate this summer, or the messy passage of TARP in 2008. One paradox is that pressure on Italian and Spanish bond yields may get a lot worse, even as their new governments start to deliver reforms – 10-year yields spiking above 9% for a short period is not something one could rule out. For that matter, it’s quite possible that French yields could rise above 5%, and even Bund yields could rise during this critical fiscal union debate.
Moreover, this could happen even as the ECB moves more aggressively to lower rates and introduce extra measures to provide banks with longer-term funding. And U.S. bond yields may fall – or at least not rise – despite improving U.S. growth data through end-year.
Meantime, global equity markets could follow a more muted version of their early Q1/09 sell-off until the political brinkmanship is resolved. In short, the fate of the euro is about to be decided. And the pressure for the necessary political breakthroughs will likely come from investors seeking to protect themselves from the catastrophic consequences of a break-up – a scenario that their own fears should ultimately help to prevent.
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