Benjamin Franklin once said, “Creditors have better memories than debtors.”
My faith in that statement was tested in 2016. That’s because debt markets drove borrowing costs to “fiscally-challenged” countries like Greece, Italy and Spain down to lows not seen since the introduction of the euro.
But my core conviction that bond investors can see financial boogiemen – real or imagined – in every bush has been restored in the last couple of weeks, as European debt yields have started to rise. The spreads between France and Italy, on one hand, and Germany, on the other, are at levels not seen since 2012, when Europe really was on the financial brink.
To be sure, bond investors do have reason to worry. In France, Marine Le Pen announced her candidacy for the presidency with a promise to establish a “national currency” – political-speak for dumping the euro.
In Italy, bad debts in the banking system are still on the minds of investors. All European governments have a disconcerting propensity to find their bonds being held by the countries’ major banks. This makes bank examinations and bail-out negotiations really dicey for all of them, but Italy – Europe’s third-largest economy – is in worse shape than all the other eurozone countries in this regard.
And then there is Greece. As we pointed out in our Week Ahead publication Monday, their cooperation with the various creditors is being strained at the moment as Greece is buckling a bit under the pressure of the strict guidelines put to it by its European creditors.
In all of these situations, an old financial term is reentering the discussion: “redenomination risk.”
This is the risk of a country abandoning the euro and going back to its own legacy currency. While that is not expected to happen, the idea that it might seems to be at least partly behind some of the higher yields we are seeing in Europe.
My View: We have been here before, with serious questions being raised about the viability of the euro and the strength of the European resolve to keep its union in place. I don’t expect the outcome to be different this time, but just as in 2016 we will have to see what happens with this year’s potential political upheavals.
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