Investors listened to Christine Lagarde last Thursday and put away their guns after her speech in Frankfurt. The President of the European Central Bank announced the creation of a mechanism to prevent financial fragmentation of the euro zone. Translation: She has created a new bazooka that will fire when markets again bet against the sovereign debt of European countries, as they did in 2012. It is a deterrent that is activated only when there is enemy fire on the bonds of the countries of the South and unlimited.
Expectations that spreads had risen amid the possibility that they would soar have faded after the ECB’s order. Investors had stressed the markets on the back of the central bank’s approval of 50 basis point rate hikes and the political strife in Italy.
The risk premiums of Spain, Italy and Greece have remained stable and have even eased after the ECB meeting and despite the Italian crisis. The Spaniard is around 126 basis points, the same as a week ago; and the Italian is below 240 points, a level reached after Italy’s powder keg exploded earlier in the week due to Mario Draghi’s resignation as Italy’s prime minister.
Risk premiums are the spread between the German 10-year bond, which investors see as a safe haven given the strength of the German economy, and the rest of the world’s bonds. It is one of the most important references used by financial analysts to assess a country’s financial health. Investors are demanding more profitability from countries they see as more unstable or financially vulnerable. The higher the risk, the higher the return. As a result, they charge more to buy the bonds of the most indebted countries and charge less when Germany issues debt.
The ECB’s interest rate hike last Thursday, the first hike in 11 years and the sharpest increase in just over two decades – no increases of this magnitude have been approved in Europe since 2000 – made us think of an economic slowdown and countries with higher levels of debt or with poorer health in their public finances are more exposed.
During the sovereign debt crisis of 2012, markets bet on Greece, Spain, Italy and Portugal, the member states with the most deteriorated finances after the Great Recession, and questioned the future of the euro as a single currency. The Spanish risk premium reached 640 points on July 24, 2012. Investors’ relentless onslaught ended when Mario Draghi, then-captain of the ECB, uttered his 14 mythical words exactly a decade ago. On an afternoon in late July 2012, the Italian warned: “The ECB will do everything to preserve the euro. And believe me, that will do.” [el conocido Whatever it takes, en su versión en inglés]. Draghi’s rhetoric fell like a bucket of cold water among investors who bet against the southern countries and ended up saving the euro.
A decade later, Lagarde also uses the verb to placate markets.