Are the fiscal crises in the Eurozone and the US over?
The government debt crises in the US and Europe have dominated headlines and captured investors’ attention in recent years, but market trends suggest the danger they pose may be fading.
For more than three years, fiscal problems in the US and Europe have been among the biggest concerns for investors everywhere.
The US has seen bitter political disagreements about increasing the “debt ceiling”, the limit on the maximum level of national debt the Treasury can hold. This has led to fears that the world’s largest economy may default on its payments to holders of US government bonds.
Meanwhile, in the Eurozone, slow growth and soaring government debt in the weaker economies have made investors unwilling to lend to these countries, creating a risk that they too may be forced to default. The political and economic consequences of such a default would be severe, and could even threaten the survival of the euro itself.
Together, these crises have resulted in a great deal of volatility – frequent sharp movements in prices – in the markets, especially in riskier assets such as shares. They have also persuaded many investors to seek out “safe havens” for their wealth in some surprising places – see our article ‘Europe’s favourite safe havens’ for details. However, over the last few months the worsening trend seems to have come to an end.
In October 2013, many US government services were temporarily shut down as the US Senate argued over whether or not the debt ceiling should be raised, yet share prices remained largely unaffected. The S&P 500, an index of leading US shares, has since gone on to reach new record highs.
It is a similar story in Europe. Even the most troubled European economies, such as Italy, Spain and Greece, have seen their shares rise steadily since the middle of 2013.
So are markets saying that the crises are now over? That may still be too optimistic, but there are certainly reasons to believe that the worst is behind us.
Europe now has time to act
The European Central Bank (ECB) has said that it will do “whatever it takes” to stabilise markets and prevent a government debt crisis in the weaker Eurozone economies. It is also making good progress in forcing Eurozone banks to recognise bad loans and to strengthen their balance sheets, which should reduce the risk of a future banking crisis.
At the same time, painful economic reforms are starting to deliver benefits for some economies, most notably Ireland. As a result, the outlook for growth is improving, and budget deficits and debt levels are starting to come under control.
It’s true that Europe’s politicians still have a great deal of work to do. The flaws in the design of the single currency zone that allowed the crisis to become so severe must be fixed to prevent similar problems in future, and this will not be easy. Many Europeans – especially those in northern European economies such as Germany – are increasingly doubtful about the benefits of the Eurozone and about even more integration between Europe’s economies.
However, the ECB’s actions mean that politicians now have more time to act. And a steadily stronger economy will make it easier to convince voters to support the necessary changes. Progress will probably be slow and uneven – but, overall, Europe appears to be heading in the right direction.
US public finances are improving
Meanwhile, in the US, there is more reason for immediate optimism. Because the arguments over the debt ceiling dominated the headlines towards the end of last year, many investors have been slow to notice that underlying trends in the US government’s finances are steadily improving.
The budget deficit – the amount that the government needs to borrow each year – fell to 4.1 per cent of GDP in 2013, having been as high as 12.1 per cent in 2010. This is likely to shrink further in the next few years if growth strengthens.
Politically, there is still a large gulf between the Democrats and the Republicans on government spending. This could make it difficult to reach an agreement next time the debt ceiling needs to be raised, meaning that the threat of another government shutdown could return in the future.
But this is not a new issue. Difficult budget negotiations are common in US politics. Last October’s shutdown of government services was certainly not a one-off – there were 17 government shutdowns between 1976 and 1996.
Political battles can certainly cause disruptions, as we saw last year. However, investors should focus on the bigger picture. The US economy has got through these types of events in the past with no lasting damage, giving us reason to believe that it will do so again.
A brighter outlook
It’s clear that, in the short term, the news is likely to be mixed. The process of fixing Europe’s problems won’t be smooth and we could easily see more political drama in the US. We should be prepared for alarming headlines through 2014 and beyond.
However, it also seems likely that these events will affect investors less than they have over the last few years. The behaviour of markets since the second half of last year suggests that investors are beginning to look through the short-term noise and focus on long-term trends instead.
In both cases, these long-term trends are encouraging and suggest that a way out of the recent problems is getting closer. It may still be too early to say that the US and European crises are over, but they are likely to trouble markets much less in the year ahead.
To find out more about how the US and European fiscal crises may affect your investments, check out the latest insights from Barclays experts at our online Research Centre. For more information about the European economic outlook, see ‘Europe unite’ on the Barclays Wealth blog.
If you would like information on our products and services please call
+44 (0)20 7574 3212*