Fisher Investments Editorial Staff
Others

On PIIGS and Needles

By, 07/15/2010

Story Highlights:

  • The latest Fed meeting minutes show concerns about US economic growth—some of it tied to Europe debt troubles.
  • Despite fears European debt problems would curtail growth in the region, eurozone industrial production climbed in May, and European banks continue to demonstrate they're healthier than assumed.
  • Though PIIGS aren't problem-free, they've encouragingly conducted successful, heavily demanded bond auctions at reasonable rates lately.
  • As economic positives prove to carry more weight than European problems, perhaps investors will return their focus to strong global fundamentals, paving the way for the end of the correction.

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Minutes for the latest Federal Open Market Committee (FOMC) meeting in June showed a concern that "financial markets had become somewhat less supportive of economic growth" tied to Europe troubles. Though the FOMC minutes revealed a slightly lowered annual growth forecasts for the US economy and recognition of weakness in some economic areas, Fed officials declared no new additional stimulus was currently needed and strength in the business sector should support continued economic recovery—something we wholeheartedly agree with. 

It's no secret fears of a PIIGS default have rattled capital markets' nerves. But the FOMC comments are a bit strange since European Central Bank (ECB) President Jean-Claude Trichet said just last week the EU faced less risk now from the PIIGS and other head European economists expressed the worst was over in the European sovereign debt "crisis." (Mind you, neither US nor ECB central bank officials are infallible in their statements and views—and we don't judge the ECB to be overwhelmingly more spot on in pronouncements than the Fed.)  

Fed officials may have cause to be more optimistic these days, however. Despite worries European debt problems would curtail growth in the region, the latest data show eurozone industrial production climbed in May for the third straight month—up 0.9% from April and 9.4% from the previous year—with all sectors seeing growth. Plus, the euro is up quite a bit off lows to the dollar—indicating renewed investor confidence in the eurozone monetary union of late. 

European banks also continue to demonstrate they're healthier than most assume—or might have fathomed even six months ago—the expiration of the ECB's one-year emergency lending facility passed without fanfare, flouting fears it could trigger major funding issues for European banks. The Markit iTraxx Financial Index of credit-default swaps for 25 major European banks and insurers (including Banco Santander SA in troubled Spain) fell the most in two months, and confident investors are buying bank bonds at the fastest pace in six months ahead of European bank stress test results coming in a little over a week from now (more detailed results should be made available in early August).  

Additionally, though PIIGS aren't problem-free, they've encouragingly conducted successful, well-subscribed bond auctions at reasonable rates lately: Portugal just raised €1.68 billion in a debt auction (despite Moody's downgrading the country by two notches the day prior), and Spain successfully raised €3.5 billion and €6 billion in two auctions over the last month. Three more Spanish auctions are planned this month, the first of which will be held this Thursday. Greece recently sold €1.25 billion of bills in an oversubscribed sovereign debt auction—granted this was largely Greek banks rolling over debt used as collateral at the ECB. 

There's no doubt trouble spots remain in Europe. But, remember, just recently there were fears of complete euro abandonment leading to a eurozone dissolution—the fact these apocalyptic alarms are no longer sounding suggests those fears were greatly inflated by jittery sentiment. Thanks to steps taken by European policy-makers, which despite some initial foot-dragging, seem to have largely staved off any likely larger fallout. And certainly, now there is little to no sign of any contagion. Helpfully, the soon-to-be-operational eurozone emergency fund will provide additional support for European banks should they need it.  

As economic positives prove to carry more weight than European problems in directing the region's economic trajectory, perhaps investors will increasingly ignore the rumbling of the PIIGS and return their focus to strong global fundamentals, paving the way for the end of the correction.

 

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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