Reuters:
After another week of confusion and turmoil in Europe, investors are
ditching whatever hopes they once had for a conclusive solution to the
debt crisis.
That may foreshadow a gloomy holiday season in markets, especially if
wary investors opt to reduce risk in their portfolios and take refuge
in US Treasuries and the dollar.
Just weeks after it seemed leaders had drafted a master plan to solve
the crisis, doubts rose about whether Greece would back a 130
billion-euro bailout.
Disaster may have been averted when Greece, under fierce EU pressure,
agreed over the weekend to form a new government that would approve the
deal and stave off bankruptcy.
But that did little to calm investors, who were already looking ahead
to the next problem: Italy. Italian bond yields hit a euro-era high of
6.4% Friday, raising fears the country may soon need a Greece-style
emergency bailout.
The Greek agreement "may spark a brief relief rally," said Alan
Ruskin, head of global G10 currency strategy at Deutsche Bank. "But it
won't last and we will soon go back to focusing on Italy."
"At the end of the day, it does seem like a grand plan is elusive at
best," said David Ader, head of government bond strategy at CRT Capital
Group in Stamford, Connecticut.
"We've seen one European bank and one US brokerage fail. We know there
are strains for French banks. We're wondering how long it will be before
Greek default worries spread to Italy and Spain," he said. "In a
situation like that, money managers are going to decide to simply take
their risk down."
Flight to safety
Investors are betting the market will see evidence of that as
soon as this week, as flight-to-safety flows help boost US Treasury
debt, lift the dollar against the euro and weigh on stock markets around
the world.
The biggest fear is that a disorderly default in Greece or elsewhere
would ripple across the global financial market the same way the Lehman
Brothers collapse did in 2008. That, investors fear, would probably be
enough to plunge the global economy into recession.
"This is going to be pretty negative news for risk markets," said Jack
Ablin, chief investment officer at Harris Private Bank in Chicago. "We
are going to see a continued flight-to-quality tomorrow."
Benchmark US 10-year note yields dropped more than 29 basis points in
the past week and a half as worries about Europe overshadowed signs of
economic improvement in America.
Ashraf Laidi, CEO of Intermarket Strategy in London, said he expected
the euro to struggle again this week after losing nearly 3% against the
dollar last week. By year end, he said it could fall below $1.30. It was
around $1.38 Friday.
"This past week really raised some tricky questions," he said. "For the
first time I can remember, the possibility that Greece really could
leave the Eurozone was being talked about in cafes and bars as well as
on trading desks."
The weekend deal in Greece may stabilize things a bit in that it
suggests Greece will keep the emergency funds flowing while making the
tough spending cuts needed to get its fiscal house in order.
"What we had been afraid of was a stalemate. Now it seems the hard cuts
will be made. I think equity markets will cheer this," said Michael
Yoshikami, president and chief investment officer at YCMNET Advisors in
Walnut Creek, California.
The cheering may not last long, though.
"These 24-hour risk-on rallies, I don't know how much longer people are
going to be willing to do that," said Ader. "Sell-offs are getting
deeper because the rallies are only short-covering moves. People are not
getting long and putting on bets that everything is suddenly OK."
From Greece to Italy
Deutsche Bank's Ruskin said the focus is likely to shift
quickly from Greece to Italy in the weeks ahead, and that should mean
more volatility and unwillingness to take on risk.
Italy's debt-to-output ratio stands at 120%, second only to Greece in
the 17-country Eurozone, and its borrowing costs are rising.
Prime Minister Silvio Berlusconi recently refused a loan offer by the
International Monetary Fund and his government may be on the verge of
collapse.
"Berlusconi says Italians are not feeling the crisis but that's because
the European Central Bank has been providing high levels of liquidity at
low interest rates and buying Italian bonds," Ruskin said. "That begs
the question, should the ECB stop that to show them this is really a
crisis?"
"I have to believe a lot of investors like me are thinking this could be
the start of Italy week," said James Paulsen, chief investment
strategist at Wells Capital Management in Minneapolis. "Italy is going
to rapidly rise on investor radar screens and may be the bigger story."