Optimism has not been an emotion experienced by too many Europeans of late. Yet that positive feeling is creeping into the markets. The big stock exchanges in Europe are all off to strong starts this year: The Dax index of German stocks is up 16 percent. Even the Athens stock exchange is up 21 percent. The bond markets, meanwhile, are easing borrowing costs for Spain and Italy, with yields below 6 percent on 10-year bonds. An impressive performance, considering the euro crisis is far from over and a risk still exists that Greece won’t have the money to pay bondholders come March 20.
So why the sunnier feelings? Investors have a lot of reasons, some of them contradictory. They all show how far Europe’s markets have come since the onset of the crisis in late 2009. There are five in particular:
- Despite the risks, the odds are mounting that Greece will get its 130 billion euro ($170 billion) bailout before March 20. The Germans, long the heavies in talks with the Greeks, have signaled a willingness to get the deal done. Angela Merkel’s government is showing signs of flexibility on the aid and the writedown of Greek debt by private bondholders. If the Germans sign off, the Greeks get the rescue and a default is avoided. That’s no guarantee Greece will crawl out of its hole. But avoiding a default for now means all kinds of unforeseen consequences are avoided as well.
- The European Central Bank’s newfound willingness to lend banks as much money as they want for three years is proving very effective in supplying Europe’s financial system with extra liquidity. The longer-term refinancing operations (LTROs) allow Europe’s banks to post iffy collateral—like the banks’ holdings of Greek sovereign debt—with the ECB, which provides cheap loans in return. The three years are long enough to bridge the crisis, and the money gives the banks time to improve their balance sheets and boost their own lending, the ECB hopes.
- A better firewall is being built. This one’s complicated, but essentially it’s this: The Europeans have financed a facility that can lend to cash-strapped states, defend against market attacks on member states’ sovereign debt, and also aid banks. This facility is to be succeeded by a permanent fund to defend the euro area starting in July. Under prodding by the International Monetary Fund, the Europeans may decide in March to merge the borrowing power. Alongside more money for the IMF, the result may be more than 1 trillion euros. That’s a lot of firepower if more attacks on sovereign debt materialize.
- Italy is turning into an asset and not a liability. In the waning days of Prime Minister Silvio Berlusconi’s rule, the Italian government, along with the Parliament, seemed incapable of warding off the contagion from Greece. With the fall of Berlusconi and the appointment of Prime Minister Mario Monti, the situation has changed dramatically. Monti’s government of technocrats has pushed through sweeping reforms in a matter of weeks. Yields on Italian government bonds have fallen steadily as a result. Spain’s government is also making progress.
- The core of the euro region is holding together better than expected. The German economy is still performing well. France, though not in Germany’s league, is not faring badly and avoided contraction in the fourth quarter of 2011. Although recession is coming to Europe, it may not be as severe as originally feared. Greece, in other words, has not infected the entire Continent. And if the worst should come to pass and Greece defaults and leaves the euro area, some think this could actually strengthen the currency zone in the end.