Beyond the EU Rescue, Signs of a European Rebound Mount

Debt Crisis Eases, European Rebound Visible
Debt Crisis Eases, European Rebound Visible

For months, European leaders dithered as the thorny but manageable problem of how to deal with Greece's overindebtedness ballooned into an existential crisis for the European Union itself. Matters reached a tipping point last week as sovereign bonds got hammered, world stock markets tanked and deadly riots broke out in Athens.

Rumors swirled that the euro, a reserve currency like the U.S. dollar, was on the verge of disintegration, and wolf packs of speculators hoping to profit from its demise circled. Staring into the abyss, European leaders were forced to put aside infighting and grandstanding to respond in a big way. And over the weekend, respond they did.

On Sunday, EU policymakers unveiled a trillion-dollar European rescue plan consisting of financing and loan guarantees to calm the world's fears of an escalating sovereign debt crisis. The European Central Bank performed yet another dramatic about-face when it said it would intervene in secondary markets to buy up sovereign bonds.

Shrinking Bond Spreads

Many of the package's details remain sketchy. But that's beside the point. The EU telegraphed to creditors that it would pull out all the stops when it came to taming pandemonium. And for once, the markets were pleased with the results. Major stock indexes around the world, including those in the U.S. and Europe, soared.

More important, the threat of contagion seems to have been meaningfully halted. Greek 10-year bonds posted their sharpest gains ever, with yields falling 570 basis points and spreads narrowing to within 400 basis points of comparable German bonds. Yields on two-year Greek debt tumbled a record 1,269 basis points as the prospects of painful restructuring now seemed to be off the table.

Yields for debt issued by Portugal and Spain -- the two countries often fingered as the next dominoes in line to fall after Greece -- also came down sharply. Spreads on credit default swaps for peripheral European states including Greece also fell, signaling that investors are finding plenty of comfort in the latest measures. And the beaten-down euro rallied sharply.

A Strong Cyclical Recovery

As DailyFinance's Dan Burrows had pointed out, U.S. investors had overlooked much positive economic data emerging at home -- such as blockbuster jobs report -- during their fixation with the slow-motion train wreck that appeared to be unfolding in Europe. Indeed, the crisis has also overshadowed what now appears to be a stronger-than-anticipated economic recovery in Europe as well.

On Monday, Germany reported that exports had climbed at the fastest monthly pace since 1992. March's 10.7% rise breezed by analyst forecasts and marked a major acceleration from the 5.1% registered in February. Imports surged 11%. Those figures corroborate a slew of other recent bullish data about rising business confidence and accelerating manufacturing.

And it's not just Germany: The strong cyclical recovery in Europe seems to encompass everyone but Greece, according to recently published analysis by JPMorgan. Manufacturing inventories were on the rise, and inventories remain lean. And despite the crisis, "sentiment in April continued to trend higher in Italy, Spain, and Portugal, suggesting that the cyclical improvement in the data remains relatively broad-based across countries," bank analysts wrote in a April 30 report.

Moreover, the newly announced package may go beyond merely alleviating anxiety about a crisis and more directly boost economic growth for the eurozone. Dramatic, demand-destroying austerity measures such as tax hikes and big cuts in government spending now seem less likely. That could add a tailwind to the "strong cyclical lift" that JP Morgan had forecast.

Putting Off Tough Decisions

Of course, there's no free lunch, and investors should expect the bailout to have consequences as well. Inflation fears have been ignited again, and gold prices held steady near record levels despite the reduction in uncertainty as a result of the stabilization plan's announcement.

And by agreeing to intervene in secondary markets to prop up government bonds, the ECB has lost plenty of leverage in pushing governments to get loans at better rates the old fashioned way: making tough decisions to cut spending, which would ultimately lead to better results in the long run. Little wonder, then, that the maneuver is evoking mixed emotions despite the overall success of Sunday's announcement.

But for now, European authorities have finally secured the luxury of time to worry about those issues amid a better economy down the road. And that was hardly a sure bet as politicians fiddled amid growing turmoil just a few months ago.