Is End of Europe’s Debt Crisis Near?

Europe’s debt crisis sent investors spinning in the first half of 2010. Will it also dominate the headlines in the second half? If July’s first few days of trading are any indication, investors are off panic-mode but remain very much on edge.

Take a look at how some key risk-o-meters in Europe have performed since the start of the month.

Europe’s common currency, the euro, has been one of the biggest victims of Greece’s debt crisis and its fallout on other struggling Southern European economies. These days, however, analysts and investors are scratching their heads over the currency’s recent run against the U.S. dollar: The euro, which is down today, is nevertheless trading at $1.2574 compared with $1.2229 at the end of June. On May 4, one euro bought $1.1917.

The euro’s bounce suggests Europe’s political leaders have made some headway in warding off worries about a break-up of the euro currency area.

Indeed, investors kicked off the second half of 2010 by giving European governments a rest and worrying about the global economic recovery instead. A batch of disappointing reports on the U.S. economy even helped push the beleaguered euro higher. Meanwhile, the European Union’s decision to “stress-test” banks has given investors hope that market fears about banks may soon lessen. Spain, the market’s latest punching bag after Greece, successfully raised cash from the bond markets both this week and last, easing concerns about a big debt repayment due at the end of this month.

Like the euro, the British pound has risen in value against the dollar to $1.5110 from $1.4939 on June 30. It was as low as $1.4336 on May 18. Britain has surprised naysayers by forming an effective ruling coalition government that has made progress on the country’s big budget deficit. The U.K.’s important “triple-A” credit rating looks safe for now. So much for the idea that Britain is the next Greece.

The result: Some analysts are talking about the sovereign-debt story moving away from Europe in the next few months and hitting the U.S., which also has a massive budget deficit.

But it’s unclear whether Europe’s troubles can really go away that fast. Despite the euro’s gains, most currency analysts remain bearish, with some still expecting the currency to hit parity against the dollar. Analysts at Dutch bank ING put out a report today saying a euro-zone break-up remains a possible scenario.

And while Europe’s bond markets are in better shape than they were a few months ago, they’re still under considerable pressure.

As the first half of the year wound down, even stronger economies like France were starting to worry investors. Banks were growing very wary of lending to each other. Some of the pressures in European money markets are now easing. The cost to insure the debts of Greece, Spain, Portugal, Italy and Ireland is lower than it was at the end of June, according to data provider CMA DataVision. Investors are talking about the possibility of buying bonds of highly-indebted European countries.

“People are probably feeling a little bit more comfortable,” says Huw Worthington, an analyst at Barclays Capital in London. “The spreads are becoming attractive now.”

But there are still not enough signs that investor worries are actually going away. Worries about Europe are “going to stay,” Mr. Worthington says, though the news-flow may improve.

For one thing, the borrowing costs of countries along Europe’s aouthern fringe remain painfully high. The cost to insure their debts using derivatives suggests investor concern remains elevated. People seem to be waiting for a Greek government default.

What could turn things around? The results of Europe’s bank stress tests at the end of this month could help draw a line under Europe’s problems – as happened in the U.S. Stronger-than-expected readings of economic growth in Asia and the U.S. could dispel fears of a “double-dip” and make investors more confident that austerity measures taken in Europe won’t push economies into reverse. But without good news on these fronts, it’s still very possible that another market flare-up could bring fears of rolling European defaults back to the fore.

Reference:
http://blogs.wsj.com/marketbeat/2010/07/07/is-end-of-europes-debt-crisis-near/