How the US central bank is propping up Europe’s dodgiest economies
By
MoneyWeek Editor
John Stepek Nov 01, 2010
Print this article
It's all about America this week.
The world's markets will be on tenterhooks until Wednesday's over. By then, we should have a good idea of the results of the mid-term elections. More importantly, the Federal Reserve will have revealed how much more money it plans to print.
The Fed's money printing has annoyed leaders of many countries. The US (regardless of what its politicians say) seems to want to drive the dollar lower. The idea is that this will make its exporters more competitive. But that's bad news for rivals, particularly export-dependent countries such as Japan.
However, Europe has been noticeably content to let the euro rise.
Exporters in the eurozone can hardly be enjoying the weak dollar. But there's a good reason why the European Central Bank (ECB) is happy with Fed money printing. That's because it's helping to prop up the most fragile eurozone economies.
How the Fed has been propping up Europe's weakest economies
An interesting piece on the Bloomberg newswire this morning suggests that quantitative easing (QE) by the Fed has helped to prop up Europe's most fragile economies.
One of the biggest stories of 2010 so far has been the Greek debt crisis. It put an end to the post-financial crisis global stock market rally. And it also drove investors to look more closely at other weak members of the eurozone, such as Portugal, Spain, Ireland and even Italy.
The 'peripheral' countries have fallen out of the headlines since. An EU bail-out package and some easy stress tests persuaded the market to focus elsewhere. And indeed, recently these countries' bonds have even seen a bit of improved performance.
For example, the price of Portuguese bonds rose in October (in other words, the cost of borrowing for Portugal fell), reports Bloomberg. That's even though the country has had problems agreeing a budget to cut spending and raise taxes for 2011.
Special FREE report from MoneyWeek magazine: Don't be fooled - house prices will fall again!
- Why UK property prices are set to collapse by 30%
- When it will be time to get back in and buy up dirt cheap property
The government cut a deal with the opposition to let the budget pass late last week. But it's hardly confidence-inspiring. And as Erik Nielsen of Goldman Sachs put it, the budget won't solve all the country's problems. "I remain nervous about the deeper, still unaddressed structural issues in Portugal."
Meanwhile, Greek longer-dated bonds have been rising even though the country recently admitted that its 2009 budget deficit clocked in at more than 15%. That was from the original estimate, last year, of below 3%.
Investors have started taking big risks
As Charles Diebel of Lloyds Banking Group tells Bloomberg: "I'm not convinced the recent outperformance of these bonds is being driven purely by market fundamentals." In some cases the economic situation "is getting worse". But "what has changed is the improvement in risk appetite and the expectation for another round of Fed QE may have had a lot to do with it."
In other words, cheap money policies across the world are driving investors out of 'safe' assets such as Treasury bonds, and into riskier, higher-yielding assets, such as peripheral eurozone debt.
This might ring a few bells. The "search for yield" is what got us into this mess in the first place. It was the collapse in interest rates that drove investors to put money in sub-prime debt. They wanted the extra yield. And they were happy to take the word of the credit ratings agencies that it was safe to do so.
We all know how that panned out. And a similar desperate quest for returns seems to be pushing investors just now. It feels just fine playing it safe when everything around you is collapsing, and the threat of deflation means that you can stick your money into any bank account and hope to get a real return.
Don't be tempted to invest in dodgy European bonds
But it's a lot harder to maintain that calm state of mind when markets are rising, and 'safe' investments are actually losing you money after inflation. Eventually, you start thinking: "Why not invest in a bit of dodgy European government debt? After all, if it all goes pear-shaped, they'll get bailed out anyway."
Yet as Charles Morris, head of HSBC's Absolute Return Fund tells Bloomberg: "There are temporary supportive forces that help [peripheral bonds] now, but I can't see the end to this problem that escapes some very painful choices."
And if the Fed doesn't print enough money on Wednesday to keep this rally going, chances are that investors will start to focus on the fundamentals again. That could be ugly for risky assets across the world, not just stocks.
Of course, in the longer run, these problems will have to be confronted one way or the other. Which is why it would probably be good news if the Fed can resist simply throwing the printing presses into overdrive. But I wouldn't want to take any big bets either way before the decision is in. If it's yield you're looking for, I'd suggest you take a look at the current issue of MoneyWeek. Our cover story looks at five different ways to get an inflation-beating income, and rates them in terms of risk and reward. If you're not already a subscriber, get your first three copies free here.
Our recommended article for today
Oil has been left behind somewhat as other asset prices have surged. But that, along with the BP debacle, means there are now bargains to be found. Here, David Stevenson tips three of the best.
Published in
Economics
| More
articles
by
John Stepek
Related articles
-
Jun 02, 2012
-
Jun 01, 2012
-
May 31, 2012
-
May 30, 2012
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.