Euro Crisis Enters the End Game

When the credit crunch first began in 2008 it took me back to the debacle that was the 1990 Japanese markets and I re-read the excellent book Solutions to a Liquidity Trap by Graham Turner. What struck me was the difference in speed between the 12 to 15 years that Japan sank further into the mire – in spite of global prosperity elsewhere – and the speed of events from 2008 to 2010. What took over a decade in Japan happened in the space of a little over a year in 2008. The speed of events that currently envelopes Europe is running at an even faster rate. The switch in attention from Greece to Italy and then France was a mere three weeks. Both the European Central Bank (ECB) and the politicians of Europe have been so far behind the curve it is truly tragic, but now we are coming to the end game for Europe much faster than they can possibly react to. This is highlighted by the sudden surge in bond yields in the last two weeks, the inverting of the yield curve between two and 10 year rates in Italy, and the failed bund auction in Germany mid-week.

There is a game of brinkmanship between Germany and the rest of Europe. Thus far, Europe has bowed to Germany’s wishes, but the first real cracks appeared this week, with the serious discussion about euro bonds. It seems highly improbable that Germany will succumb as they view this as a means for the profligate countries to escape austerity and true reform. The markets think otherwise as suddenly 10-year yields in Germany moved back above 2%. There has also been a switch in the shorter end as UK gilts have a lower yield than Germany. Japan has also switched its bond purchases away from Europe and into gilts. This is highly significant and highlights how the international community is growing tired of Europe and is voting with its feet. For the euro the risks are clear. Wednesday’s breakdown was technically significant when placed in conjunction with the failed bund auction. If the price remains below 1.3422, the pressure remains with an initial target of least 1.2873.


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Mark Carney Bank of England