Europe Again! What's Next?

May 4, 2012
 

There will be a presidential election Sunday in France. The outcome could threaten the strict austerity measures favored by Germany (the Eurozone check writer). The following is a quick summary of what is going on currently in the Eurozone.

 

1.      Eurozone

 

·        Germany’s Angela Merkel has been the architect of the austerity measure imposed on troubled Eurozone countries.

 

·        All might be a moot point if Nicolas Sarkozy holds onto power in France, but a win by his socialist opponent, Francois Hollande, would amplify a growing rift.

 

o   Front-runner Hollande is demanding that leaders forsake budget-cutting fervor in favor of pro-growth policies

 

o   The ECB’s Mario Draghi has called for a “growth compact.”

 

o   Strict austerity without credible pro-growth reforms has exacerbated economic conditions in Europe. Think Greece.

 

o   Protests are rising in Spain as the population suffers under the weight of 24% unemployment.

 

·        It almost sounds as if Hollande were mirroring policies implemented in the U.S., with its emphasis on spending, payroll tax cuts, and lip service to deficit reduction.

 

·        But will bond-market vigilantes trump the politicians, sending yields higher and rattling credit markets?

 

·        Spain, Italy, Greece and others rely on investors’ willingness to refinance debt. Or the ECB long-term refinancing operations that pumped 1 trillion into the banking system.
 

 

2.      European Central Bank: Steady as she goes

 

·        Keeps its key rate at 1% - no surprise.

 

·        Didn’t’ discuss the possibility of a rate cut – somewhat surprising, given Eurozone weakness.

 

·        The door is still open, but no near-term stimulus on the horizon; sees a slow recovery.
 

 

3.      Why should U.S. investors care about the drama in Europe?

 

·        Your timeline needs to go back only to last year – recall the volatility and seemingly endless triple-digit moves in the Dow.
 

 

4.      A peek ahead

 

·        European elections

 

o   It’s not just France! Greece holds elections on Sunday, and outgoing Prime Minister Lucas Papademos is urging his successors to maintain the austerity course.

 

o   Socialist Francois Hollande appears set to take the helm in France.

 

o   His victory is probably priced into the markets, but his anti-austerity, pro-growth platform is sure to add a new wrinkle to an already complex situation.

 

o   An Ifop poll shows a slight narrowing in Sarkozy’s deficit, but Hollande still holds an eight percentage-point lead (WSJ).
 

 

5.      Longer term: The “fiscal cliff” in 2013 will increasingly get attention

 

·        The fiscal cliff:

 

o   Expiration of the Bush tax cuts,

 

o   Scheduled budget cuts,

 

o   The end of the partial payroll tax holiday,

 

o   The expirations of extended jobless benefits all create additional uncertainty for the markets.

 

·        The cliff threatens to create a drag on economic growth that a muscle-bound Fed would have trouble offsetting.

 

·        Likely scenario: we won’t see a resolution until after the election, but a grand bargain that establishes fiscal sanity is at least a year away.

 

We will continue to monitor this situation as it develops to see what impact it may have on your portfolio.

 

Happy Spring!

 

Edward J. Kohlhepp, CFP®, ChFC, CLU, CPC, MSPA
Edward J. Kohlhepp, Jr., CFP®, MBA


Please contact us whenever there are any changes to your financial situation, personal situation or investment objectives.

 

 

Sources: 
Horsesmouth, Charles Sherry, M.Sc.

 

 

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Kohlhepp Investment Advisors, Ltd.
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