This week, I had the opportunity to talk to a number of important asset managers in Berlin who together were responsible for probably several hundred billion euros of investment in the euro area and whose customers comprise some of the world’s important sovereign wealth funds and some central banks. What they told me on the euro crisis is frankly frightening. Their messages in short:
- Foreign investors (mainly central banks and SWFs) are massively moving out of Italian, Spanish and increasingly French bonds.
- The market perception is that contagion has by now spread beyond Italy and has reached France (this morning spreads on German bonds were around 110 basis points). This has important implications: There is the danger that even a leveraged ESM is too small, because France might not be able to act as a creditor anymore and might even need funds of its own further down the road. If this is the case, only one player is left in the market which can still help: The ECB which would need to engage in large-scale bond purchases.
- Euro bonds would only be accepted by these investors (and the foreign central banks and SWFs they do business for) if they come with a framework that prevents future fiscal profligacy. There is very little trust in the tightened stability and growth pact as it has now been agreed upon.
- According to those people I talked to, there was broad agreement that the only thing that would definitely help to bring back confidence in European markets would be a bold move towards fiscal union. However, these managers were very skeptical whether policy makers would be able to achieve such a far reaching reform. The managers were all saying that given their perception of the political environment, it would take 10 to 15 years to bring about such institutional changes. (In my eyes, this is too skeptical. I believe that the necessary treaty changes or a new treaty could be in place in 2 to 3 years if there really was the political push).
- If the summit this week-end would suggest first steps toward fiscal union (there are rumors that some such elements might be in the agreement), this might provide some confidence to the markets. However, for short-term market reaction, the size of the new ESM leverage would be more important.
As these managers are those people who actually decide where to put the money and thus indirectly decide on the interest rates paid by euro countries and hence ultimately the future of the euro, this means that for the euro the question is now “fiscal union or bust”. While politicians seem to be moving closer to understanding these requirements, there are clearly not there yet. So, chances are that the results from this week’s summit will again fail to smooth the markets.
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