Has the ECB Succeeded?

 |  Includes: ERO, EU, EZU, FXE, IEV
by: Cullen Roche

Fears in Europe were quickly calmed in recent months after unprecedented moves by the European Central Bank. But since that time there have been some further signs of weakness in the regions that were supposed to benefit most from the bailout – specifically Ireland and Greece. As we noted yesterday, there were rumors that the ECB was buying Irish bonds as yields began to spike and budget woes continue to weigh on Ireland.

On Thursday Greece announced lower than expected GDP at -1.5% and a 12% unemployment rate. The worsening of both was attributed in large part to government austerity measures. Deutsche Bank analysts are now referring to Greece as a “a death spiral of government insolvency.” The IMF also commented briefly on the action in Greece: “Speculation that Greek debt restructuring may have only been postponed, rather than decisively put to rest, clearly weighs on sentiment.” Bond spreads have steadied back near their highs (after briefly declining) while CDS spreads have begun to move higher. The cumulative probability of default now sits at 49.72% – roughly a coin flip and not exactly a sign of faith in the ECB’s actions (click to enlarge images):


European Bond Spreads


European CDS Sreads

This morning, Germany reported a blockbuster GDP that blew past expectations. Markets are celebrating this move, but as I’ve explained in that past, this is the problem with the single currency system – Germany’s trade surplus imposes inherent weaknesses on many of its European trading partners. The most recent GDP strength is being attributed to “buoyant exports”:

Germany on Friday reasserted itself as the economic growth engine of the eurozone, after gross domestic product expanded at a stellar 2.2 per cent rate in the second quarter compared with the previous three months.

Buoyant exports, aided by a decline in the value of the euro, helped Europe’s largest economy post its fastest rise in decades, equivalent to an annualised rate of more than 8 per cent.

It’s not surprising then, to see the weakness in GDP reports in many of the surrounding countries over the last few days. After all, a country like Greece just doesn’t sell much to Germany and what little they do sell to Germany is less attractive than it should be because Greece doesn’t have a floating exchange rate that can adjust with trade.

So for now, the Euro is rallying and equity futures are rallying as Germany looks strong. But Germany isn’t the issue here and their strength is sapping strength from the most worrisome parts of Europe. The Euro sovereign debt crisis is far from playing out. It’s clear that the politicians in Europe will not admit that the Euro is a flawed currency system and so it looks like the IMF’s comments above are actually quite pertinent:

Greek debt restructuring may have only been postponed, rather than decisively put to rest.

The United States isn’t the only place where central bank intervention is proving to be a failure. I have little doubt that the Europeans will eventually come to the same realization.