Contagion Spreading Further to Core Eurozone

Includes: ERO, EU, EWQ, FXE
by: Edward Harrison

In a note to investors yesterday, Win Thin of Brown Brothers Harriman noted that contagion has spread to core Europe with France now paying more for debt.

France is coming under scrutiny, with one astute market contact noting that France CDS prices are now about equal to UK. This comes even as French bonds have underperformed Germany this past week, with 10-year spreads between the widening by 23 bp. We’ll stress again that it’s not a question of fundamentals, as France is closer to Germany than it is to the periphery. No, what’s worrisome is that France is coming under pressures as the contagion continues unabated. The fact that it is spreading to core euro zone is not a good thing. Belgium and Austria, two other core euro zone countries, have also seen bond spreads widen and CDS prices rise in recent days. European officials have yet to find the “game-changer” that turns market sentiment around, and so we see continued spread-widening in euro zone bond markets as well as ongoing EUR weakness. We believe that the “game-changer” remains debt restructuring coupled with aggressive IMF and World Bank-backed structural reforms, a la Latin America under the Brady Plan. A muddle-through approach will only lead to a Lost Decade for the euro zone.

If the Europeans thought their recent commitment to austerity budgets at the G-20 meeting would be well-received by markets, they were being proved wrong yesterday. Fiscal tightening will only put downward pressure on already anaemic growth in the eurozone. Win Thin sees this as euro bearish and notes "the 2005 low of 1.1640 is the next big target."

Video of the G-20 below

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