Story Highlights:
>>Fitch Ratings lowered Portugal’s sovereign credit rating. Combined with continued uncertainty over Greek fiscal relief, the news drove the euro to a 10-month low against the dollar and called into question the European Union’s stability.
>>Europe may continue to face economic challenges as its member nations run into fiscal problems, but that doesn’t necessarily mean economic stagnation.
>>Even if budget problems deepen in these countries, there are numerous solutions to stem any fall-out effects-coming from both EU and the IMF.
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Have PIIGS fears come home to roost rather than fly away? (Can PIIGS even fly anyway?) Fiscal problems revealed earlier this year were quickly priced into sovereign debt, raising fears Portugal, Ireland, Italy, Greece, and Spain could default-though Greece seemed the most legitimate threat, followed by Portugal. Austerity plans and promises of EU support calmed Greek fears for a spell, but now it’s Portugal’s turn to rattle again. Fitch Ratings dropped Portugal’s sovereign credit rating a notch to AA- on Wednesday, in reflection of its significant budget underperformance in 2009. And Fitch warned of further downgrades if fiscal improvements weren’t made. Combined with continued uncertainty over Greek fiscal relief ahead of the European summit this Thursday, the euro fell to a 10-month low against the dollar.
Hot on the European summit docket will be whether Portugal’s and Greece’s problems can undermine the EU’s stability. Of course a downgrade is never positive for a country since it increases its sovereign borrowing costs-just at a time when Portugal is struggling with the very cost of that debt. But Fitch’s move shouldn’t shock-it merely puts that rating agency closer in line with Moody’s and S&P’s ratings for Portugal. Additionally, the lack of a concrete Greek solution is probably more a reflection of Germany’s desire for Greece to try to borrow on the markets on its own first or even sell some state assets before applying a rescue mechanism. As we’ve said here before, Greece has options outside of a regional bailout-the question is whether Greece has the will.
While Portugal’s downgrade added to market fears Wednesday, remember, Portugal’s early March government debt auction was oversubscribed, suggesting investor confidence in its four-year austerity plan to improve its fiscal position. Also note, spreads for Portuguese and Greek 10-year debt over equivalent German issues have ticked higher but are still lower than seen earlier in the year, meaning the recent market reaction may be sparked by interim fear rather than fundamentals.
Sure, Europe may continue to face economic challenges as its member nations run into fiscal problems, but that doesn’t necessarily mean economic stagnation. First, growth fueled by emerging markets-together, about the size of the whole of the EU-and other parts of the world will likely pull Europe along, and second, individual nations in the union dealing with fiscal problems isn’t new and have not historically hindered growth in this region as a whole.
Coming off a global recession, there will continue to be economic problem spots in the world-even in the healthiest of times, some countries struggle. The PIIGS are receiving attention today because they feed into greater fears of EU instability, but taken as individual countries, they comprise only a small fraction of worldwide GDP. Even if budget problems deepen in these countries, there are numerous solutions to stem any fall-out effects-coming from both EU and the IMF-which decrease the likelihood of all-out default or contagion.
Early into a bull market, folks are still hesitant to embrace good news, favoring the negative stuff that confirms fears. If it’s not one thing, it’s another. News like Portugal’s downgrade will continue to drive fears, but positive fundamentals-including strong EM growth, a rebounding US economy, rising eurozone business activity, and globally steep yield curves-will drive the young bull market.
Disclaimer: This article reflects personal viewpoints of the author and is not a description of advisory services by its author’s employer or performance of its clients. Such viewpoints may change at any time without notice. Nothing herein constitutes investment advice or a recommendation to buy or sell any security or that any security, portfolio, transaction or strategy is suitable for any specific person. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
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