Skandia: Spanish bonds’ weakness containable, banks fully funded until 2015

LONDON | The latest Spanish financial turbulences are unlikely to start a new downturn for risk assets appetite, Skandia Investment said in a market commentary on Thursday. The investment management company believes that the recent weakness in Spanish bonds, although may become a new phase of the euro zone debt crisis, should not affect equities and other risk assets.

Rupert Watson, head of asset allocation at Skandia Investment Group, remarked that

“A few weeks ago Italian prime minister Mario Monti said that the eurozone crisis was ‘almost over’. Shortly afterwards Spanish government bonds and to a lesser extent Italian government bonds sold off sharply. However, while Monti’s comments were overly optimistic with a debt crisis that will probably last years, we think that the problems are largely contained within the troubled countries and will not be an impediment to further equity gains.”

In 2010 and 2011 weakness in peripheral bonds led to weakness in equities and a slowdown in the global economy. At Skandia, analysts think the impact is going to be much less significant this time around, even if Spanish and other peripheral bonds weakened further.

Watson said that there are three main differences between the situation this year and 12 months ago, one of them being the long term refinancing operation (LTRO), which in his opinion has greatly reduced the contagion between banking sector and sovereign debt. Banks, especially those in peripheral economies, would be now fully funded until 2014/2015. The LTRO also would have showed the ECB’s commitment to ensure financial stability and support the euro zone. In fact, the report noted,

“the European Financial Stability Facility has been expanded and along with the soon to be European Stability Mechanism could provide substantially greater and more flexible support for sovereigns.”

Skandia highlighted that the peripheral economies have taken steps to reform their economies and reduce their deficits.

“While these steps are incomplete and are perhaps less than is optimal, they are nevertheless a significant improvement on what was in place in 2010 & 2011,” the experts said.

“The imbalances within the euro zone took years to create. Likewise, the rebalancing will also take years to complete and is made harder by the inability of the affected countries to devalue their currencies. The economic pain, along with the political and social problems this causes, is likely to continue for some time.”

Skandia’s Watson directly  pointed at German chancellor Angela Merkel as the key European leader to solve the crisis the monetary union is experiencing since 2008. In his view, Germany and the rest of the euro zone could bring the crisis to a close now through agreeing to the joint issuance of Eurobonds.

“However, Germany (rightly in our view) sees it as critical that new governance structures are in place before such measures are considered to ensure that the affected countries continue to reform. Without these reforms, Germany could find itself funding other parts of the euro zone for years to come without any effective exit route.”