Fear gauge enters the red zone
Europe's debt crisis risks escalating out of control as the world economy slides towards a double-dip slump with few shock absorbers left to limit the damage.
By Ambrose Evans-Pritchard
Fear gauge enters the red zone - Telegraph
9:25PM BST 22 Sep 2011
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Key indicators of credit stress have reached the danger levels seen before the Lehman Brothers failure three years ago, with Markit's iTraxx Crossover index – or "fear gauge" – of corporate bonds surging 56 basis points to 857 on Thursday.
Societe Generale led a further rout of bank shares, crashing 9pc in Paris on concern that it might need recapitalisation to cope with losses on Italian and Spanish debt.
The yield spread between Italian 10-year bonds and Bunds reached a fresh record of 408 basis points before the European Central Bank (ECB) intervened in late trading. It is near the level at which LCH.Clearnet raises margin requirements, the trigger that forced Greece, Portugal and Ireland to request bail-outs.
Global investors appear shaken by the refusal of the US Federal Reserve to come to the rescue yet again with quantitative easing (QE3) even though it was never likely the bank would launch fresh stimulus with core inflation running near 2pc or in the face of protests from Capitol Hill.
The global flight from risk has hit Europe hardest. Peter Possing Andersen from Danske Bank said Europe’s authorities are running out of time. “The financial markets have lost faith in the current policies and the economy is on the verge of a recession. Radical action is needed to short-circuit the negative spiral,” he said.
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“Segments of the financial markets are dysfunctional and access to credit is being shut down. European policymakers must take imminent and bold measures. Until this happens, the market will grind slowly but surely towards disaster. The current policy of austerity risks killing the already-fragile recovery and is making a bad situation worse in terms of debt dynamics,” he said.
Mr Andersen said Greece needs greater debt relief to break the “vicious circle”, while the ECB should step in with “unlimited” bond purchases from countries such as Italy that are essentially solvent.
Andrew Roberts, credit chief at RBS, said recent weeks’ grim economic data have rendered Europe’s “muddle through” policy unworkable, pushing weaker states towards the brink. The latest PMI data show that export orders for manufacturing tumbled to 44.8 in September, the lowest since mid-2009.
Ominously, the PMI data for China is flashing contraction warnings for the third month, dropping further than it did during the depths of the Great Contraction, suggesting the loan curbs are starting to bite.
“We are in a fresh cyclical downturn within a structural slump/depression. We need global co-ordinated monetary action and the ECB must cut rates by 50 points. It made a terrible mistake by raising rates in July,” Mr Roberts said.
The IMF has slashed its growth forecast for Italy to a stall speed of just 0.3pc in 2012, a level that risks havoc with debt dynamics. The country must raise €260bn by late next year. Each 100-point rise in borrowing costs increases the budget deficit by €2.5bn.
The IMF warned that emerging markets are nearing the buffers of credit growth and are losing their fiscal room for manoeuvre. It said China’s domestic loans have risen to 173pc of GDP, “well above” the safety level.
The IMF fears “significant” losses on $1.7 trillion of local government debt, raising the risk Beijing may need to rescue the system. “The consequences could be a substantial worsening of China’s public debt metrics and a narrower scope for future fiscal stimulus,” it said. China cannot safely respond to a second global shock by opening the floodgates of cheap credit again.
Professor Giuseppe Ragusa from Luiss Guido University in Rome said the ECB has the power to halt the eurozone’s escalating crisis by pledging to buy up €2 trillion of bonds. “They would not have to buy the debt. The promise would be enough,” he said.
Such bold action appears unlikely. The ECB has intervened hesitantly over the past six weeks, without the overwhelming force needed to convince markets that it will back-stop Italy’s €1.8 trillion debt – the world’s third largest.
The bank is constrained since the policy is vehemently opposed by the Bundesbank and by German president Christian Wulff, who has accused the ECB of breaching the EU treaty law.
David Owen from Jefferies Fixed Income said the Bundesbank increased its balance sheet by €50bn in August alone to help shore up the Eurosystem. It has lifted its liquidity provision eightfold to €421bn since the crisis began, almost as much as the ECB itself.
On Thursday IMF managing director Christine Lagarde said the ECB must continue to provide “solid, reliable” funding for euro-area banks and economies as parliaments in the region pass measures into law to fight the region’s debt crisis.
The ECB “plays and can play and I hope will continue to play a critical role,” she said.
There are clearly limits to how far this policy can be pushed without a treaty change. Otherwise it amounts to fiscal union by the back door. The task of purchasing bonds and recapitalising banks must fall to the EU’s bail-out fund, but it will not be ready until ratified by all national parliaments later this year. Europe faces a tense Autumn.
Fear gauge enters the red zone
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