Comment: The ugly underbelly of the European experiment

Julian Chillingworth, chief investment officer and manager of the Rathbone Blue Chip Income and Growth fund, on why the eurocrats’ words are wearing thin for European investors...

There’s a distinct lack of leadership over Europe, and markets are impatient. Amongst the politicians, the rumours, and the bureaucratic nonsense, peripheral bond yields are sky-rocketing, and equity markets are bracing themselves for a looming banking crisis and the potential for some serious earnings’ downgrades.

The mood is cautious; there’s a sense of foreboding, but in and amongst the noise and G20 pen-pushing, a dangerous assumption is developing that someone, somewhere is going to do the right thing and magic it all into shape.

It is an assumption, dare I say it, based on the very disbelief that we are facing a hole again and the usual ropes simply are not hauling us out. To risk stating the obvious, this is not just a banking crisis, but a crisis of credibility, and as time marches on, it becomes increasingly etched and self-prophetic.

Finger pointing

Forget Europe for a second (if you can), and take the US as an example. President Obama pointing the finger for his country’s woes at Europe, in shameless fashion, having developed amnesia about sub-prime and higher core inflation. Markets are not stupid, which is why Operation Twist failed to inspire.

Isn’t it a strange world when we assume that the financial world is safer because the European Central Bank (ECB) has leveraged itself up with useless bonds; that the European Financial Stability Facility (EFSF) has swollen to the tune of trillions; that it’s fine to shift toxic assets from one entity to another, in the hope that they develop some form of half-life and vanish? It’s only a matter of time before this realisation hits home too.

The Germans, the Finns, the French, and the Austrians, we Brits – everyone has a gripe. This is the ugly underbelly of the Euro experiment, on show for the world to see, the crippling agendas and endless face-offs, and painful stereotypes. A little less conversation, a little more action please! There’s no point gazing longingly at Asia for respite – it’s doing okay for now, but that trade knot that is Europe needs smoothing out, and fast.

We all knew that Greek bonds would have to take more than a 50% haircut, and that the EFSF would have to gear itself up, to bail-out the banks and prop up the bond markets. However, dancing around the issue for months and months has only led to more damage. This proposal was first put forward in early summer, and serves to underline the inflexibility of the current structure to react to a crisis.

Perhaps it is the best and worst time to mention the prospect of contagion and the Spanish and Italian debt ‘mountains’ then. Could the European banking system withstand a default there? I think not. The banks are already stifled by over – regulation – it’s painful transition period (to what end now, I’m not sure), and meanwhile, bond markets take the mantel and become ever-more punitive.

Oscillating markets

We all know that sentiment has a poetic license of its own, and there’s room for some serious volatility ahead. Europe’s elite need to ring-fence Spain and Italy before the pressure on the system intensifies and sentiment rages out of control. Markets are taking solace in the slightest glimmer of a solution, for now, but words are wearing thin and lacking gravitas.

At the time of writing, the ECB is grunting about easing rates and offering emergency liquidity for banks – it’s seen as a positive. Any moves must now be emphatic. Recent ineptitude does not bode well for the next G20 deadline this month, and we are likely to see markets oscillate between hope and despair for a while longer.

One thing is for sure, the Eurocrats’ ‘playtime’ is up.