Spanish Fleas?

What’s up with the markets?

Once again Europe appears to be ground zero in the global economy. Like last August, concerns about contagion within the Euro-zone are encouraging investors over there to move their cash to safe havens in Switzerland, Japan, and the US. We’ve seen the dollar rally against the Euro, as our stock market pulls back and our bond market flirts with record low yields.

Greece, while problematic, isn’t the major issue. It’s Spain. After their government took over one of its largest banks, investors became concerned their entire banking sector is shot, and that Spain itself will need a bail-out. But the Spanish economy is so large that the European rescue fund isn’t big enough to handle it. Accordingly, Spanish interest rates have risen dramatically, approaching 7%.

European policy-makers are not without tools, though. One option is to grant the European Stability Mechanism—their bailout fund—a banking charter, thereby giving it access to the European Central Bank and potentially unlimited funding. That’s what enabled the Fed to undertake so many extraordinary measures so quickly in 2008, supporting money market funds, large corporations, the asset-backed securities market, and other financial institutions beyond their member banks. While controversial, the Fed’s actions prevented a full-fledged economic collapse.

But Europe doesn’t yet have a broad-based lender-of-last-resort that can break the negative feedback loop between weak banks and distressed sovereign bonds. There’s no guarantee that in an era of brinksmanship, leaders won’t make a mistake that causes major economic problems. As a result, markets continue to be rocky. Grab your seat belts!

Douglas R. Tengdin, CFA
Chief Investment Officer
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