04.17.2012
By Markets Media

Fixing Europe

On Monday, the discussion among traders was that of yields on sovereign debt of European Union member nations. Default fears continue to rise with Spain and Italy in the crosshairs of bond sellers. The fears were confirmed on Tuesday as a giant rally in U.S. equities left European markets rather flat and untouched.

Again, the question remains: why haven’t these countries done a strategic default? Why not end the pain now and work over the next decade to turn things around and work toward a more fiscally conservative future?

It’s not just the cushy lifestyle, big pensions, low tax rates and other problems associated with the societies of Greece and such. It’s the fear of another Lehman Brothers-esque domino effect. It’s great to identify as a united “European,” but not if it’s going to bankrupt an entire continent and quite possibly, the rest of the world.

“If Greece [defaults], then, Portugal, maybe Spain, and Italy, what’s left? …well uncertainty that they don’t want to address that or conceive of it – a position the ECB under Trichet and now Draghi have stated numerous times,” Matthew Hendrick, senior analyst at Hedgeye Risk Management, told Markets Media. “Note too that under the existing constitutional treaties, there isn’t explicit language accounting for the exit of a country from the Eurozone and/or the EU.”

“While the exit of Greece and Portugal could be justified, Eurocrat consensus seems unwilling to let a Spain or Italy leave due to their economic size and the cross border losses that would result on the sovereign and bank sides, that would threaten an already anemic economic outlook for this year and next,” added Hendrick.

Even if European nations decided to get their act together overnight, outside forces are almost encouraging them to keep afloat longer. Massive multi-billion dollar pledges to the International Monetary Fund have come in from Japan and the United States and more could be on the way. Over $1.3 trillion of liquidity has been pumped into the crisis thus far.

“While we don’t see the IMF greatly leveraging its balance sheet on Europe from here (note the Spring annual meeting of the IMF/World bank begins this Friday), and we view the EFSF + ESM as an insufficient firewall for the entire region, they, along with such measures as the LTRO and SMP, help contribute to a buffer to the region and help insure that over the short to intermediate term we will not see a breakup/exit of a member country,” said Hendrick.

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