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!

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