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Q & A: Europe's slow moving train wreck

Posted June 8, 2012 | Categories: Q&A
1. By Friday of last week, US stock's had given up all of their 2012 gains, but then the market rallied by almost 3% in the first three days of this week. Whats going on?

US stocks peaked this year in early April, but then weak economic news caught up with the market.   A string of weak US jobs reports, increased concerns about recession in Europe, the likelihood of Greece leaving the EURO and the deteriorating situation in Spain has led investors to seek safety again, primarily in US government bonds. The 10-year Treasury Bond yield fell below 1.5% at the end of last week, and US 30 year mortgage rates hit a record low 3.67%.

2. I thought the Greek bailout this Spring calmed markets.

That; true, anytime there is a hint of coordinated policy efforts to stem the slow moving European train wreck, the market responds with optimism and overreacts a bit. Last March the EU, ECB and IMF engineered a Greek default on the majority of its debt and a second bailout package with new austerity promises attached.  But the budget cutting going on in Greece, UK, Spain and elsewhere has worsened the economic outlook and as the EU tips back into recession,   governments have fallen across Europe and there is a renewed push for pro-growth policies rather than just blind austerity measures.  The Greek rescue package was supposed to keep the government funded until June, but they are reporting that they may still be short of cash because of falling tax revenue as the economy goes through a deep recession with the unemployment rate hitting 21.9% in March.  So in essence the market overreacted with optimism to the original deal and the strong US  jobs numbers for January and February, and is now overreacting a bit to the bad news.

3. But Greece is a very small country, how can it have such a large impact on US markets?

Markets are globally connected.  The fear is that the contagion will continue to spread from Greece to Spain to Italy and France.  Spanish 10-year government bond rates have reached 6% and their unemployment rate has topped 24% as austerity measures and the continued fallout from a burst housing bubble makes Spain the next target for an IMF or EFSF rescue package.    And if Greek elections on June 17, usher in a government that reneges on the deal made for the last rescue package, Greece will leave the EURO and no one really knows what the repercussions will be on global financial markets.  When Greece drops out of the euro, how will contracts be settled,  will there be bank runs in Spain and Italy?  With much of Europe in recession, any large financial disruption would be particularly damaging to the real economy and the US markets are worried about that.

4.  So why the rally this week?

Primarily because of statements from the ECB and some FED presidents that have led markets to believe there is a greater chance of additional central bank easing. If Central banks act decisively as the ECB did with its Long Term Refinancing Operation (LTRO) last spring, markets will likely rebound, and no one wants to miss out on that!

-- Carl Bonham

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