The prices of European sovereign debts, under ferocious attack for much of the last week, finally started to rise amid optimism that central banks and other institutions are closer to containing the fiscal crisis that threatens to tear the euro zone apart. The yield on France’s 10-year debt has fallen and Italian 10-year yields are below the critical 7 percent level. And while the outlook may have in fact brightened since the depths of late November, it is still far from clear that the divisions within the euro zone have reached a turning point.
A powerful rally in global debt and equity was sparked on Tuesday as the Federal Reserve, the European Central Bank and other central banks took a coordinated action to make it easier for banks outside the U.S. to borrow in dollars. That is important to their operations and will lesson the need for them to sell dollar-denominated assets to raise cash.
The coordinated central bank action was interpreted by some investors as a sign that the European Central Bank is ready to take a more aggressive role on December 8th and 9th to bolster the bond markets of Europe and stabilize sovereign yields at lower, more sustainable levels. That sentiment was encouraged in part by comments in a speech by ECB president Mario Draghi, who said the central bank may take a bigger role in resolving the crisis if governments take steps toward tighter fiscal union. Draghi also suggested that it might accept quickly drawn fiscal agreements that sidestep the longer, formal process of revising the EU treaty.
Is the crisis reaching a resolution? Nick Firoozye, Nomura’s London-based senior rate strategist for Europe, the Middle East and Asia, argues that the contest of wills dividing Europe and hindering a resolution of its debt crisis will continue until at least early next year, at which point it would be possible that the ECB may have won enough concessions to soften its stance on supporting bond markets and lowering yields. Here are edited highlights of his conversation with Institutional Investor contributing writer Steve Rosenbush.
1. Are we witnessing the end of the euro or the euro zone as we now know it?
The odds, I believe, are less than 50 percent. But you have to plan for it.
2. Even Greece will remain in the euro zone?
We have to be prepared for the possibility that the euro does not survive. But if anything, I believe that the most likely scenario--if there is an exit--is an exit by Greece. If Greece leaves, it will do so before it receives €60 billion to €80 billion in bailout funds next year. Once member states fund that bailout, they will not want Greece to leave. The exit would be in lieu of a bailout. Otherwise, it could be a few years before Greece leaves, if ever.
3. Is the ECB likely to back down before December 9 and agree to a U.S.-style program of massive bond buying, to bring sovereign yields down to more sustainable levels?
I don’t think the ECB is there yet. December 9 will see proposed treaty changes; the question is, will they go far enough to make the ECB happy with the outcome? Conditions are likely to get get worse before they get better.
4. Hasn’t the ECB already engaged in some form of quantitative easing, because it hasn’t been able to ‘sterilize’ some small-scale bond purchases of sovereign debt by draining reserves in other areas?
The full allotment is a form of quantitative easing, already. The ECB has given banks as much cheap money as the system could want to take down, as long as banks have enough collateral. The whole purpose of sterilizing bond purchases is a bit of a wash. There is excess liquidity in the system. For several weeks in the past, the ECB wasn’t able to do full sterilization. In that sense, the last week, although worrisome that the ECB could not fully sterilize purchases, does not necessarily mean the ECB is going to go ahead with a bigger program of QE. For the time, the ECB will continue to put pressure on governments.
5. What, exactly, is the basis for the ECB’s reluctance to take stronger action to lower yields?
It is very much concerned with moral hazard. They are concerned that whatever they do, it will just delay the inevitable. They are also concerned with their inability to impose conditionality. It can’t say we will buy bonds if you implement fiscal measures. It is supposed to be independent. The most threatening thing it did was send a letter to Berlusconi. It believes it is not its job to lower bond yields. It is the job of governments to lower those yields.
