The U.S. can do no wrong and the Europeans can do no right, at least in the eyes of bond investors.
Fearful investors are fleeing European bonds and other euro assets and pouring money into U.S. Treasuries, even though both face explosive debt problems.
The demand for Treasuries illustrates that investors expect U.S. policy makers to overcome their debt impasse long before the Europeans manage to come up with an enduring solution to their insolvency problems.
The failure of euro-zone leaders to devise a debt-restructuring plan for Greece that would not trigger bond defaults, and fresh worries that the crisis is spreading well beyond the confines of peripheral euro-zone nations to such key economies as Italy and Spain, is hammering the bonds of the more troubled countries.
On Monday, yields demanded by investors for the risk of owning Spanish or Italian debt jumped to the highest levels since the currency’s inception in 1999. Italy’s benchmark 10-year government bonds climbed 41 basis points to 5.68 per cent, a spread of more than 300 basis points above German bonds, regarded as the most secure in the euro zone. As recently as mid-April, the spread was only 112 points. Yields on 10-year Greek bonds are closing in on an astronomical 30 per cent.
The limping euro fell more than 1.5 per cent against the U.S. dollar and 1.8 per cent against the Swiss franc, as investors turned to what they regard as safer investments.
U.S. Treasuries remain firmly at the top of the must-own list, even in the face of a political logjam in Washington over the debt ceiling. As a result of the influx of capital, the greenback rose against 14 other currencies, including the Canadian dollar, while the yield on the benchmark 10-year U.S. Treasury bond plunged below 3 per cent for the first time in almost two weeks.
It was a remarkable display of confidence that U.S. policy makers will resolve their deep divisions over deficit cuts and lift the statutory borrowing cap, without which the government could face the first default in the country’s history. The U.S. Treasury has warned it will be out of funds by Aug. 2 if the $14.3-trillion (U.S.) debt limit is not raised by then.
After failing to broker a deal over the weekend between Republican and Democratic lawmakers on deficit reduction that would include raising the borrowing cap, U.S. President Barack Obama warned Monday that such a default could plunge the U.S. economy back into recession and inflict damage on global financial markets. But he ruled out any stopgap measure that would temporarily lift the borrowing cap. Republicans are adamant they will reject any deficit-reducing plan that includes tax increases. Most Democrats, including Mr. Obama, oppose cuts in spending on Medicare and other social benefits.
Yet as the clock ticks toward the Treasury deadline, global investors seem remarkably sanguine about the unfolding political drama.
In Europe, meanwhile, the markets have already concluded that a Greek default is inevitable. What worries investors is that delays in declaring the obvious are only making matters worse for other debt-ridden countries.
“Investors are extremely skeptical of everything the euro zone has done,” said Marko Papic, a senior analyst with Stratfor, a global intelligence company in Austin, Tex. “What we have seen so far is that every time the Europeans solve one issue, another one very quickly pops up.”
There seems to be no stomach for addressing the critical institutional problems at the heart of the current crisis. Investors regard the euro zone as broken, but politicians don’t seem to have the capacity or political capital to fix it.
“The markets started with the assumption the EU system would be able to fix a number of things, but it hasn’t been able to,” said Nicolas Véron, a senior fellow at Bruegel, a Brussels think tank. “The more [investors] see the EU institutions unable to fix situations – and the debate on private-sector involvement [in the Greek restructuring] has been quintessential in this respect – the more they take flight.”
The euro area has become the focus of the sovereign debt crisis, rather than the U.S., Britain or Japan – all of which have huge deficits of their own – because of the currency zone’s faulty design, said Edward Harrison, Washington-based founder of Credit Writedowns, a popular financial blog. While 17 countries share the common currency, there is no central fiscal authority or executive body capable of enforcing rules or addressing the vastly different levels of competitiveness within the region.
“The question in the U.S. is about political risk, not national solvency … That's why yields in Greece and Ireland are so much higher.”