Panic turned to euphoria today as investors worldwide heaved a giant sigh of relief on news that European policymakers had agreed on a nearly $1 trillion loan package to end a fast-spreading sovereign debt crisis that began in Greece but was threatening world markets – and the U.S. economic recovery.
After imploding last week in a perfect storm of investor panic, which was then cubed by high frequency computer trading run amok, the S&P 500 surged 4.4 percent today, erasing about two-thirds of last week’s losses. It was the S&P’s biggest gain since March 23, 2009.
And the party was global. The MSCI World Index, which tracks stocks in both developed and developing countries, jumped 4.8 percent, the most in 13 months. As the euro reversed its downward trend against the dollar, the Stoxx Europe 600 Index rallied 7.2 percent, the most since November 2008. Germany’s DAX Index rose 5.3 percent. France’s CAC 40 Index increased 9.7 percent. Spain’s IBEX 35 Index surged a record 14 percent.
Meanwhile, the premium investors demand to hold Greek 10-year bonds over the German bunds shrunk 484 basis points (4.84 percent). And the price of Treasurys and gold both fell, as last week’s manic flight to safety reversed, and investors began pouring money into riskier assets again.
But Was It Irrational Exuberance?
There’s no question that the European bailout package, dubbed “shock and awe” for its size and speed, was necessary after last week’s credit market freeze and stock market implosion. By agreeing to a bigger-than-expected 750 billion euro ($959.4 billion) rescue fund to support the most indebted European countries, the European Union and International Monetary Fund whisked away fears that Greece and other highly indebted countries might default on their sovereign debt, or the euro experiment might fail. Meanwhile, the Fed joined the European Central Bank (ECB) in restarting a program, launched in 2008 during the U.S. credit crisis, in which the Fed lends U.S. dollars to the ECB, which then can lend then to dollar-strapped European banks.
The question on some investors’ minds, however, is whether the recent moves will be sufficient to keep the U.S. recovery going. In particular, questions linger about the European Central Bank, which was divided on the plan, and said bond purchases would be “sterilized,” meaning they wouldn’t increase the money supply. As some experts see it, the ECB is still animated by inflation fears, deeply rooted in the hyperinflation of the Weimer Republic, when the real risk now is deflation. Along with tough fiscal constraints in Greece, Spain and Portugal, too-tight monetary policy could slow growth throughout Europe.
The Domino Effect
Slower growth in Europe could complicate our own recovery by reducing demand for U.S. products and services, which have also become less competitive in Europe as the dollar has strengthened against the euro. That’s not good for industries that are heavily dependent on European sales, like pharmaceutical companies and agricultural exporters.
A slow growth story in Europe could also hurt markets that are heavily dependent on commodity sales. Such markets include Chile, Morocco, South Africa, Indonesia and even Canada and Australia. On the other hand, emerging markets with growing domestic demand like China, India and Turkey could be beneficiaries of lower commodity prices.
As for the U.S., the recovery may now depend more on investment by businesses, which, unlike consumers, are cash-flush. But whether companies open their wallets will depend significantly on the policymakers. If they continue to act like they did over the weekend to deftly maintain liquidity in financial markets – and take the tough steps to cut structural budget deficits longer term – investor, business and consumer confidence should continue to rise.
Step one is crisis management. Step two is keeping the recovery moving. Step three is addressing long-term structural deficits – and not just in Greece.