The main reason there’s a euro zone debt crisis is that investors think there is one. But the opinion of that fickle group may be changing.
The best mood indicator is the spread between German 10-year bond yields and those of troubled governments. For Ireland, Italy and Spain that measure is 27 percent narrower than the November 2011 peak. While the yields – 7.6, 6.2 and 5.5 percent respectively – are still uncomfortably high, both the level and the trend suggest that the governments will be able to fund themselves on the market.
What has improved? Not Greece, for sure. The fiscal deficit is not narrowing, the politicians are still bickering and negotiations on the next chapter of the sovereign’s soft default – a “voluntary” writedown of 70 percent of the value of privately held debt – are going badly. The news from Portugal is also discouraging. The Irish fiscal deficit is hardly shrinking, although the country is now running a current account surplus.
But for the first time since the middle of 2011, these countries are starting to look too small to matter, and investors are looking at the euro in a brighter light. The economy is looking healthier – the January Markit index of euro zone purchasing managers’ sentiment was the highest in four months. Also, the European Central Bank has come through with unlimited three-year funding for banks. That is reminiscent of the U.S. Federal Reserve move of March 2009, when it pushed enough money into the system to restore confidence.
Finally, European politics look less menacing. Euro zone leaders remain far from inspirational, but they seem determined to cut deficits as fast as the slow economy will let them. And the new Italian and Spanish governments seem committed to bringing durable fiscal and economic improvement.
The good news could vanish quickly, and the financial imbalances which sparked the crisis of confidence will shrink slowly. A new crisis could come at any time. Investors might change their minds, again. But for now, there’s a strong case to be made that the worst is over.