It was a bit of a trip down memory lane yesterday for market watchers. Not really since 2011 have headlines about European periphery banks and bond yields been around to get traders slightly nervous about the financial system but yesterday saw a slight flare up.
Banco Espirito Santo (LISBON:BES), a Portuguese bank, revealed it may miss a bond payment and has, after days of selling pressure, suspended its shares pending an announcement. Portuguese bond yields climbed higher from their recent, deflation-induced lows while German debt crashed higher as investors showed a real “flight to quality”. Gold and the yen were also well bid and continue so this morning.
Now we don’t believe this is too much of a concern in the longer term. Firstly, apparatus and safety mechanisms to protect the European and world banking sectors remain in place and could adequately deal with an additional bailout of BES should it be needed. As it stands at the moment the capital buffers of the Portuguese government – estimated at around EUR6bn – will be more than enough to cover losses.
Secondly, this may be a good thing in the short term as it will allow the European Central Bank to accurately game stress tests scenarios on the European banking sector. We know that Credit Agricole (PARIS:CAGR), the French bank, is one of the largest shareholders in BES and the geographical ties between the Portuguese and Spanish banking sectors are obvious, so this is where we would expect pressures to build should fears increase.
Thirdly, from a more global point of view Portugal only makes up around 0.013% of global market capitalisation. While these moves are important and interesting, a large systemic wobble is not likely. Once again, it may prove useful. We have noted in the past that recent runs higher in equity markets to new record levels are not the result of strong, sustainable economic fundamentals.
Bourses have run higher following huge flows of cheap money looking for yield. In the past quarter the pushes to new highs have come with falling volumes; a classic signal that there is little heart in the move and that a regression lower is expected. The slight slip in risk sentiment has allowed those investors an excuse to square positions and take some money off the table.
What this is however, is a reminder that the European debt crisis was made chronic by Mario Draghi’s 2012 pronouncements that the European Central Bank would do “whatever it takes” to protect the Eurozone. Chronic diseases still have flare-ups. This move is as much about Banco Espirito Santo as it is about the disinflationary, low growth economy in the Eurozone at the moment. It is no surprise that these moves took place after drastically poorer than expected industrial production numbers from Italy and France from the month of May.
German inflation numbers this morning have matched their preliminary figures, rising by 1% from a year previously but, as yesterday suggested, it is the periphery where we will be seeing the focus shift.
