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An American inconsistency

An American inconsistency

US investors believe Europe will muddle through
But where’s the move to invest in euro assets?

by Gabriel Stein, OMFIF Chief Executive

Mon 23 Jul 2012

At conferences and meetings in the US, where I spent the last ten days, the discussion inevitably turns to the euro area crisis. An interesting inconsistency often emerges. While there are of course as many different views among Americans as among Europeans, I have noticed a significant group of financial market actors who believe economic and monetary union (EMU) will somehow muddle through.

If, by ‘muddle through’, these observers believe that no member country will leave EMU, then I disagree. But it certainly is a valid point of view. It is also a standpoint that euro area politicians would very much like to hear. Perhaps the more so since they have hardly impressed the world with their capacity for either muddling through or for coming up with any form of credible and politically/economically acceptable solution.

Part of the reason for this American sanguinity may be due to an innate optimism, a feeling that, ultimately, things will turn out all right. After all, this has frequently turned out to be the case in the past. Part of the explanation is also that the US has its own problems. A survey from Bank of America Merrill Lynch, referred to in the Financial Times on 18 July, shows that one in five American asset managers perceive their own country’s threatened ‘fiscal cliff’ to be a more serious threat than the euro crisis. But these views are not mutually exclusive. Rather, they imply that asset managers tend to concentrate on one problem at a time and presumably look nearer to home first.

However, there is an inconsistency here. Because if you do believe that EMU politicians really will muddle through and that the euro crisis (crises, rather) will be solved, then surely you should pile into euro sovereign debt? Even assuming that muddling through implies that Greece will leave the euro – which does seems to be more accepted – why not buy Spanish or Italian debt? Any form of successful resolution in Europe must mean that markets relax their view of the vulnerability of at least those two countries. Bond yields are probably unlikely to converge on German levels in the same way as they did in the first years of EMU; but with 10-year Italian and Spanish bonds yielding just over 6% and 7% respectively, there is plenty of scope for narrowing vis-à-vis the Bund’s 1.2%. However, there seem to be no signs of American mass buying of euro sovereign debt (or of other euro assets either, for that matter).

The Americans may be innately optimistic believers in the ‘muddle through’ option. But that doesn’t seem to stretch towards investors putting their money where their mouths are.

Why is this important? Primarily because the US is the one major economy where there is scope for growth to surprise on the upside this year. But even if it does – and much will depend on whether the fiscal cliff is postponed or renegotiated – more favourable economic news from the US is unlikely to bring much solace to euro area asset prices.

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