When Europe’s finance ministers emerged in the early hours of May 10th to announce a €750 billion ($950 billion) rescue of the embattled euro zone, some joked that they had thrown everything at the problem “including the kitchen sink”. It turns out there are a few more implements left to hurl, The Economist reported.
Germany this week announced a ban on the naked short-selling of euro-area government bonds and shares of some financial firms, and on the buying of sovereign credit-default swaps by investors who have not also bought the underlying bonds. Angela Merkel, Germany’s chancellor, gave warning that the euro is at risk as she defended the ban. If Germany hoped to calm markets, it failed. Shares slipped, as did the euro (see chart). Euro-zone solidarity fractured, too: Christine Lagarde, the French finance minister, said she regretted the decision.
The pipes of the world’s financial system are gumming up again. One concern is that American money-market funds, which Barclays Capital reckons have lent $300 billion-$500 billion to European banks, are cutting their exposure to Europe, making it hard for banks and companies to borrow. LIBOR, the interest rate that banks charge one another to borrow, has jumped to levels not seen since August. The pressure is growing on EU states to get a €500 billion stabilisation fund, the biggest chunk of the bail-out, up and running.
In the interim the European Central Bank (ECB) has been doing its bit (see later story). An initial €16.5 billion in government-bond purchases is thought to have focused on three of the smallest and most distressed euro-zone markets: Portugal, Ireland and Greece. That led to a quick thaw in these markets, where a week earlier trade had almost ground to a halt. On May 18th Ireland auctioned €1.5 billion in bonds and saw fairly robust demand for its debt. Two days later Spain attracted decent interest in a sale of ten-year bonds.
Yet the improvement is far from uniform. Spain had earlier struggled to sell all of a planned €8 billion issue of shorter-term notes, eventually scaling the amount back to €6.5 billion. And improving prices in the secondary markets may be deceptive because in the case of Greece and Portugal, at least, the only real buyer seems to be the ECB.
A significant change in European bond markets is under way. Europe’s decade-long “convergence play”, in which investors bet that over time bond yields across the euro zone would come together, is unravelling. Investors who had assumed an almost equal risk of default among euro-zone countries are now relying on emerging-markets desks to help them understand the credit risks they are taking. “Our emerging-markets traders were scratching their heads at some euro-zone government spreads,” says Andrew Balls of PIMCO, a bond investor. “What you have happening is an emerging-market crisis but it is happening with a country [Greece] that is a member of the euro zone.”
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