A widening crisis spooks global markets

Kevin Carmichael
2010-05-10 09:40:00

As Greece approves austerity measures, fears over debt contagion send investors flying from stocks and bonds and into safe havens, such as U.S. Treasuries and gold

Europe’s debt crisis is going viral.

Even before Thursday’s technical glitch sent stock markets into a temporary freefall, skepticism about the euro bloc’s ability to manage its fiscal problems had put global markets on edge.

Growing fears that the Greek fiscal mess is just the tip of a sovereign debt crisis have spooked markets for weeks; on Thursday, those worries sent investors scurrying from stocks, bonds of weak countries and some commodities and into the havens of U.S. Treasuries and gold. The latter soared $22.30 to $1,197.30 (U.S.) an ounce.

“We’ve seen a crisis start in a country – Greece – become regional, impact the whole of the euro zone and is on the verge of truly going global,” Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., which oversees the world’s biggest bond fund, said in an interview on CNBC.

“We should take this very seriously.”

The Greek parliament’s approval of austere budget measures that are a condition of a €110-billion ($146-billion) bailout did nothing to assuage the concern that growing government debts in places like Greece and Portugal will cloud prospects for the global recovery.

That showed up in the trading of assets that are closely tied to the world economy. Crude oil fell $2.81 (US) to $77.16 per barrel in New York and the Canadian dollar plunged.

The yield on the 10-year U.S. Treasury note declined to 3.44 per cent from 3.54 per cent yesterday as prices rose because of strong demand for what is considered the safest of assets.

The head of the European Central Bank, Jean-Claude Trichet, left benchmark lending rate for the euro zone at 1 per cent yesterday, and reiterated that he is confident that European-IMF program for Greece will work.

?That wasn’t enough for some investors and analysts, who criticized Mr. Trichet and other European authorities for doing too little to contain the crisis to Greece.

There is growing pressure on the ECB to buy the debt of European countries in the secondary market to ease interest rates, much like the U.S. Federal Reserve did during the financial crisis. Mr. Trichet told reporters in Lisbon that the idea wasn’t discussed by policy makers.

“We’re talking about 21 per cent of world GDP that seems to be at a significant amount of risk at the moment,” said Peter Hall, chief economist at Ottawa-based Export Development Canada. “There is some nervousness on this side of the pond about the reluctance of Europe to come up with a credible response. There is some frustration.”

Spain yesterday had to pay 0.7 percentage points more than it did nine weeks ago to persuade investors to buy €2.35-billion of five-year debt yesterday, paying 3.5 per cent after having its credit rating downgraded.

Spain’s debt auction was a tangible example of debt contagion, as investors made jittery by Greece’s request last month for a lifeline from its partners in the euro zone and the International Monetary Fund grow wary of Europe’s other debt-strained economies. Moody’s Investors Services said in a report yesterday that there is a risk that the malaise will spread to banks in Britain, Italy, Spain, Portugal and Ireland.

For context, that’s a higher yield than investors are demanding from Thailand, where the government has been locked in what has been at times a bloody struggle with street protesters for a month.

Speaking to reporters outside the House of Commons in Ottawa, Finance Minister Jim Flaherty said he is monitoring the situation in Greece and the rest of Europe “carefully,” adding that he has been in contact with this counterparts in the Group of Seven countries.

Mr. Flaherty indicated that his message to his European allies is to get the situation in hand.

“This is a risk that has to be managed,” he said. “It’s very important that our European colleagues manage the risk within the European Union and that’s what we’re having discussions about on an active basis.”