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When Greece first kicked off the European sovereign debt crisis, market watchers pretty much unanimously decided that the whole mess would work like this:
That would have been bad enough. But it’s actually working out somewhat worse than that.
Instead, after investors (German translation: speculators) grew weary of Greece-bashing, and the European powers-that-be tried but failed to stop the rot, the market is shifting into all-out systemic crisis mode, with only a brief day or two worrying about Spain.
Right now, investors are not on a whirlwind tour of Europe’s garlic belt. They’re not just picking off the currency bloc’s weakest members and punishing their bonds.
There’s an element of that, of course. The costs of insuring government bonds from the likes of Greece, Portugal and Spain are back up around the levels they held in early May, even despite the $1 trillion shock-and-awe rescue package. And Spanish and Italian bond yields are rising, reflecting, at least in part, renewed investor nerves.
The difference now is that French and Belgian bonds — previously seen as safe — are also coming under some pressure. Their equities are still drawing in decent demand. But the bonds — the first to be hit in this situation — are under strain. Only northern European bonds, chiefly from Germany, are still immune.
That’s not good. It’s a sign that the domino effect, where pessimistic investors prowl around the weak links and knock them down one by one, is not working. Now, says Steve Barrow, an analyst at Standard Bank in London, it looks like the market wants to “flatten all the dominoes at once.”
So, why the shift in gear?
It seems to reflect a very broad sense that the biggest risk of all — some sort of breakdown of the euro system — is being taken increasingly seriously.
The idea of Germany pulling out was laughable just a few weeks ago. Now the suggestion is generally met by economists with a “well, you never know.”
An ECB working paper from December — “Withdrawal and expulsion from the EU and EMU: some reflections” — is becoming a must-read for bankers. You can read it here.
Euro break-up is very unlikely. No doubt about that. But still, the development of this crisis from a Greek debt shakeout to a fundamental analysis of how the euro works, has been alarmingly fast. And that’s what’s going on now.
As Simon Derrick, an analyst at The Bank of New York Mellon in London puts it in the light of that working paper:
“It’s difficult to see how, technically, a member state could leave the euro zone. But it is clear that such an outcome was not considered by officials to be an impossibility.”
Germany might be best off leaving now, before its southern cousins, Derrick suggested, stressing that he still considers this to be a “low probability event.”
It is clear now that the euro zone can’t carry on as before. There’s just no way back.
But after all this, what will it become? As the currency tumbled to a fresh four-year low against the dollar earlier Monday, even despite a burst of disappointing U.S. data last week, it seems few investors really want to hang around to find out.
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The Source is WSJ.com Europe’s home for rapid-fire analysis of the day’s big business and finance stories. It is edited by Lauren Mills, based in London.
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