ALBERT HERTER

‘ACROSS EUROPE, GLIMMERS OF OPTIMISM EMERGE, ‘ by Neil Shah & Mark Gongloss in the W.S.J.

In Uncategorized on July 30, 2010 at 15:32

Across Europe, glimmers of optimism emerge

BY NEIL SHAH AND MARK GONGLOFF,  THE WALL STREET JOURNAL — 07/28/10

Things are finally going Europe’s way.

In recent weeks, after months of crisis and questions, a number of market indicators have turned positive. Riskier sovereign debt has rallied, credit-default insurance costs are at two-month lows and the euro is flirting with an 11-week high against the dollar.

Ebbing fear in Europe has helped bring relief to other markets around the world, including U.S. stocks. But there are also signs of lingering market unease and little hope that the long-term problems dogging Europe have been solved, suggesting the welcome market reprieve may be temporary.

Most important, tensions have eased in the battered government-bond market, even as the European Central Bank withdraws its emergency support program of buying troubled euro-zone public debt. Investors, increasingly confident that European policy makers have forestalled a sovereign-debt default, at least in the short term, have taken up some of the buying slack from the ECB.

As a result, the borrowing costs of deeply indebted euro members like Spain, Portugal, Ireland and Greece have fallen significantly relative to Germany recently, making it easier for them to refinance their debt burdens. In recent weeks, the difference between the yield on Spanish bonds and relatively safe German debt has shrunk to its lowest levels since mid-May, while spreads for Portugal and Ireland have also narrowed.

Several factors are driving the improvement in European financial markets, including the nearly $1 trillion bailout announced in May, a string of well-received sovereign-bond auctions, hints of economic recovery and the recently concluded bank stress tests.

Few observers are ready to call an end to Europe’s debt troubles, however. Credit-stress indicators are still higher than normal, and many banks are still relying on the ECB for funding. A measure of European interbank borrowing costs, the three-month Euro Interbank Offered Rate, or Euribor, rose to 0.893% on Tuesday, its highest level in nearly a year. That is a sign that some banks may still be wary about lending to their counterparts.

The recent strength in some European economic indicators isn’t yet broad-based or persistent enough to declare a trend. The fiscal austerity plans of governments throughout the region could put a damper on growth for months. And if those austerity measures shrink retirement, health and other government benefits, they raise the chances of political backlash and more risks to growth.

“We suspect that concerns will resurface before too long as the economic pain brought about by fiscal tightening causes some countries to question whether they should stay within the European Monetary Union,” wrote John Higgins, senior market economist at Capitol Economics in London, in a note.

Troubled sovereign borrowers have short-term debts that will need to be refinanced in the years to come, after the bailout package expires.

Investors may be relieved that the recent stress tests of European banks didn’t produce many failing grades. But the tests’ limited scope and arguably tame stress levels have many investors concerned that they left uncovered hidden risks in the banking system.

As a result, Europe’s financial markets may be merely enjoying a predictable, and temporary, lull following the turmoil of spring and early summer.

“We can stop worrying about Europe now, but we will be revisiting this problem a year from now and two years from now,” said Guy LeBas, chief fixed-income strategist at Janney Capital Markets.

For now, rallies in the credit-default swaps market—where investors buy protection against debt defaults—have brought insurance costs back down to mid-May levels. In the past month, Spain’s credit-insurance costs have fallen 34%, while costs for Greece and Ireland are down 31% and 25%, according to data provider Markit.

The uptick in optimism is striking given that the European Central Bank has nearly halted its purchases of public debt in the past week, having bought roughly €60 billion ($78 billion) of bonds since it began in May, indicating Europe’s bond market may be starting to stand on its own feet.

Also, Europe’s economy is showing signs of improvement. On Friday, the U.K. government reported that Britain’s economy grew faster last quarter than it has in more than four years. German data have also been stronger than expected.

And countries on the periphery of the euro-zone have raised billions of euros of new funding in the capital markets recently without trouble. Last week, Spain borrowed nearly €6 billion by selling Treasury bills, paying a lower interest rate than a month earlier. Ireland is finished with over 80% of its refinancing needs for the year. Portugal will sell new debt on Wednesday.

With the crisis fading, the euro has clawed its way back to $1.30 against the dollar after falling below $1.19 in early June. Stock markets are back in the black, with the pan-European Stoxx 600 Index up 1.6% this year. Greece’s benchmark ASE index finished Tuesday 4.1% higher.

Ross Pamphilon, head of portfolio management at European Credit Management in London, said European assets could even benefit over the longer-term as euro zone countries move more quickly than the U.S. to tackle their deep fiscal problems. He is buying European corporate bonds, especially riskier bonds issued by European banks.

“Sooner or later, the focus may actually shift to the U.S.,” he said

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