Posts tagged european cisis

European Crisis

 
European Crisis: Snow Ball Effect

 

The phrase Snow Ball effect draws its analogy with the rolling of a small snow ball down a snow-covered hillside. As it rolls the ball will pick up more snow, gaining more mass and surface area, and picking up even more snow and momentum as it rolls along.
This is precisely what is happening with the European financial crisis. Starting from an initial state of small significance it is building upon itself, becoming larger (graver, more serious), and perhaps potentially dangerous or disastrous for the global financial markets.
The problem is that the Debt to GDP ratio (D/Y) in most of the EU countries is far higher than, those mandated by the ECB’s guidelines. The biggest task with the EU nations currently is to reduce this D/Y as much as they can in the coming years in order to avoid a mess. The Two ways in which this can be reduced are
  • Rising Nominal GDP (which would lead to a fall in denominator Y)
  • A falling Nominal interest rate, which would lead to a fall in the current expenses on interest and hence the deficit (The numerator D)
But what is happening in the EU zone currently, is that everyday when the government of these debt ridden countries are coming to the bond markets for an auction are paying higher and higher yield to sell those bonds (which means higher nominal interest rates) and also the budget cuts/ new taxes levied on the people will lead to a fall in the GDP growth rate. Thus, creating by what I mean a snow ball effect.
Its being said by the noted economists that A “1%-decrease in average funding costs from 2010 results in a 5-17%-point lower debt-to-GDP ratio in 2020″. But the funding cost is continuously on an up trend, creating a risk of contagion (crisis spreading from one country to other).
Thus, the investors who are demanding higher yield to buy those EU countries bond because of a higher risk, need to understand that the higher yield they command the tougher it would be for these countries to pay back their debt in future because it will create a snow ball effect and make it virtually impossible for them to pay them back.
I hope some one from EU understand simple graduate level economics read this blog or.. :D

 

 To view our earlier article on Euro Zone click here.

Author: Rahul Sonthalia, Research Head, Kredent

Is the EU bailout package enough?

Yet again the global financial markets yesterday cheered the fact that an ailing patient (EU) has being given a strong financial medicine. All the major Indices around the world were up by almost 4% on an average on account of this strong step by the EU members. A bailout package worth almost $1 trillion.

But the question is -

  • Is this something to get overexcited and start buying stocks ?
  • Is this bailout package enough to give a stability to the European financial system?

Well, the answer to the first question is NO. This is not something to get overexcited and start buying stocks. Most of the rally that happened yesterday was a short covering one and any market data do not point towards any kind of a fresh buying.

The answer to the second question is that YES it has partially given stability to the global financial system, especially EU, a short term stability. The medium and the long term risks still remain. This is clear by the fact that

  • The yield on the Greece’s and other crisis ridden EU nations two year bond fell by a hefty amount (For Greece it almost halved), however the yield on the 10 year saw only a minor correction
  • The difference between the LIBOR and the overnight indexed swap rate, the so-called Libor-OIS spread that rises as a signal banks are less willing to lend, climbed yesterday even after the rescue announcement

Thus, I strongly believe that the outlook has just improved for a very near term and there are record deficits in just about every country EU and something ultimately needs to be done about them. The current measures is just to stop a complete vertical fall and to prevent it making it look like a bubble burst. However, the slide should continue.

Moreover, what it has done is integrating a political union from an economic union, whereas the case is always the opposite around the world. Hence, if the countries getting aid do not comply to the will of the political bosses (Germany & France), could lead to an altogether different crisis.

Hence, one should use this momentum lead rally only for trading that too with strict stop loss since, nothing too good has happened