When risk becomes uncertainty
It’s going to be another panicky weekend in Europe after today’s torrid market action: the positive effects of last weekend’s emergency meetings clearly didn’t last even until Friday, and the ever-weakening euro is now dragging down the continent’s bourses. This isn’t (just) a sovereign-credit issue any more: the financial markets have worked out that there’s a pretty simple trade-off between fiscal austerity and economic growth.
At the same time, markets clearly don’t believe that fiscal austerity is going to be a reality either: Greece’s CDS spreads are now back out over 600bp, and the rest of sovereign Europe seems to be gapping out too.
Most worryingly of all, the biggest losers today on European stock exchanges have been the banks — which means that we could be heading for a reprise of the 2007 credit crunch.
The big picture here is that risk, in Europe, is being replaced by uncertainty. The difference is that risk can be priced, while uncertainty can’t, and a market dominated by uncertainty is always going to be jittery and dangerous. No one knows whether the trillion-dollar bailout package announced last weekend will ever actually exist in practice; no one knows whether there’s a Trichet Put or not; no one knows whether the historic alliance between France and Germany, in which both of them do whatever it takes for the sake of European unity, still really exists; and everybody knows that the UK now has the most eurosceptic government since Margaret Thatcher resigned 20 years ago.
Meanwhile, on this side of the pond, we’re seeing large stock swings yet again, with the Dow down over 200 points and the VIX at 33: the uncertainty in Europe is clearly spilling over to the U.S., and this time a phone call from Barack Obama to Angela Merkel is unlikely to do much visible good.
This isn’t a second financial crisis yet. But the fact is that the world’s governments and central banks have much less ammunition than they did last time around if such a thing were to emerge. So the possible downside is enormous, especially given how much markets have rallied in the past year. If you can’t stand a lot of heat, then this particular kitchen is one to avoid for the time being.