You are here: cherry > Press releases for September 2010 > Neil Dwane, CIO Europe at RCM, a company of Allianz Global Investors comments:

09 September 2010

“After the long and balmy summer, investors have returned to find that the situation in the EU is not as fundamentally sunny as the strong economic performance of Germany has suggested. “Only yesterday, we were reminded that changing the structural imbalances and entitlements in Europe will be difficult with public protests in France about the rise in retirement age from 60 to 62. Austerity measures “Whilst we have read of great initial progress for austerity in Greece, markets have also appreciated the scale of the economic challenge ahead as it watches Ireland do the right thing in terms of shared pain, compromise and austerity, and the resulting worsening unemployment, rising deficits and still falling GDP. “With the EU set to progress with austerity more firmly in 2011, investors are getting insights into what the future may hold for those economies critically weakened by the fragility of the financial sector and their own domestic structural imbalances. Politicians and central bankers around the world are all hoping to steal economic growth from the rest of the world through exports, to obviate the domestic pain and restructuring, which would otherwise be required to become competitive. “Recent German economic strength shows just how competitive Germany is at 1.15 to 1.30 to the US Dollar, but our strategic analysis shows that the PIIGS in particular need Euro/ Dollar parity. Despite the stress tests, EU banks remain undercapitalised “After the recent EU bank stress tests and the softening tone of the Basel III proposals, many had assumed that it was safe to re-enter both the equity and debt exposures of the European Financials sector. However, various nuances and suggested ideas contained within the regulatory frameworks hint at more stringent levels of capital, which mask the underlying conclusion of the previous stress tests; namely that the EU banks remain undercapitalised and that the sums are non-trivial. “Many investors remain equivocal at investing in this sector whilst there are both such huge capital shortfalls, as well as one trillion Euros of debt refinancing already to come in the next two years. But at least the EU banks, outside of Spain and Ireland, still do not have the pressing problem of falling real estate values and foreclosures now re-emerging in the USA. “Contagion risks remain extremely high in this globally integrated industry and with yield curves flattening, which will hurt net interest margins as well as the threat of a fall in the reversal of credit losses which will seriously impact earnings growth in the sector, banks look unattractive with no dividends to speak of. Will Germany save its banks, the EU or both “The leveraged positions of many German banks, both publicly quoted and publicly owned, are well known and we have said before that Germany could either save its own banking industry from its bad investments and act in its domestic interests, or it could save the economies where the bad investments were made and save the EU. It may now need to do both! “With CDS spreads now widening to the crisis levels last seen in the spring of this year, markets are again re-pricing the risk of a Greek default with the consequent threats that brings to the other weaker EU countries. Today we have seen a massive rescue rights issue from National Bank of Greece which dilutes existing shareholders by over 30%. Is this a sign of the future in these distressed economies? Euro weakness “The Euro is already seeing serious weakness against the safe haven currencies of the Swiss Franc and Japanese Yen but this may spill over to the US Dollar and the pegged Asian currencies, exacerbating their ability to grow but boosting Germany’s. Competitive devaluations and trade friction have been seen as clear ‘policy mistakes’ from the 1930s and 1970s, but with little economic traction outside Asia and Latin America, politicians and central bankers will find many domestic arguments for further monetary and possibly fiscal interventions in the search for economic growth, rather than painful restructuring. “More fiscal Keynesian responses may be tolerated by bond markets for a while but more monetary laxity and QE, in sufficient size to be effective, would cause currency weakness and inflation-hence the new highs now being made by gold. “The rock and a hard place confronts the hammer and the anvil and sparks look set to fly.” – Ends –

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