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Euro Member States May Abandon Currency, Pimco Says

The euro may become a “weaker entity” or even lose some members unless its 16 participants cooperate more closely on fiscal policy, according to Pacific Investment Management Co.

Pimco, which runs the world’s biggest mutual fund, is “cautious” on the region’s government debt, said Andrew Balls, the company’s head of European portfolio management. While Europe’s most-indebted nations are reducing spending, it’s not yet clear the cuts won’t weigh on economic growth, he said.

“The range of possible outcomes includes the preservation of the current euro-zone, albeit as a weaker entity unless urgent progress is made on a deeper fiscal union, or one or more euro-zone members restructuring their debt and also the possible exit of a current member country,” Balls wrote in a research report received by e-mail today.

German 10-year bund yields touched 2.5 percent on June 8, the lowest since at least 1989, amid speculation that weaker euro-region economies will be overwhelmed by their debts, stoking demand for the perceived safety of German fixed-income assets. The crisis drove the 16-nation currency down 20 percent between Nov. 25 and the end of last week.

Soaring bond yields in so-called peripheral euro-region nations, including Greece, Ireland and Portugal, forced the European Union to craft a 750 billion-euro ($913 billion) rescue package and the European Central Bank to start buying government bonds on last month.

‘Wait for Evidence’

“We think it is prudent to remain underweight European sovereign risk and to wait for evidence that countries with stressed debt dynamics can deliver on fiscal consolidation without undermining growth in their economies,” Balls said.

A so-called “underweight” position means the company holds a smaller proportion of the securities than the amounts in the indexes where it measures its performance.

The premium that investors demand to hold Greek 10-year government bonds over benchmark German bunds widened six basis points to 568 basis points as of 1:40 p.m. in London. The so-called yield spread between German and Irish 10-year bonds was little changed at 255 basis points, while the Portuguese-German spread widened five basis points to 258 basis points.

“We remain positive on core duration and German bunds,” Balls said. “But given the potential for euro-zone governments or the ECB to be drawn deeper into providing support, we do not see German bunds as offering significant advantages over the secular horizon compared with U.S. Treasuries.”

German government bonds returned 7 percent this year, compared with 4.5 percent for U.S. Treasuries and 5.3 percent for U.K. gilts, according to indexes compiled by Bank of America Merrill Lynch.

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