10th Decmeber Global Government Fiscal Crises overview
10th December 2009
Macro Overview
Global Government Fiscal Crises
The phenomenal growth of government debt in recent months, due to governments pouring money into the economy and banking system to aid economic recovery, has fuelled the risk that many governments may not be able to meet their obligations. Events this week have caused a dramatic turn in market risk appetite. Further concerns about the UAE and the downgrade of Greece have seen risk markets turn off recent highs. Yesterday also saw Spain being placed on watch negative by Standard and Poors.
Thoughts from the trading floor
The major concern for the market is the potential “contagion” effect that sovereign downgrades seen so far may have for other major countries running large balance of payment deficits. With many parts of Europe, including Portugal, Ireland and Eastern Europe facing great fiscal challenges, further downgrades may spark capital flights away from countries deemed to be at risk. The UK is another country touted to be at risk due to its high debt to GDP ratio. Although the US is also running a high deficit, the fact that the USD is considered to be the World’s “reserve currency” protects it in the short term. Countries such as Germany and Japan are deemed to be low risk as their budget surpluses should enable them to meet obligations for the moment.
The implications for risk appetite across the markets centres on market’s belief that government stimuli is needed to aid economic recovery, without it we may see a “double dip”. If countries are forced to consolidate fiscal positions too early and remove stimuli from the economy and hike private sector taxes before recovery has taken place, on the balance of probabilities a return to severe recession is most likely. This would be akin to the forced tightening that took place during the 1930s which drove global economies into depression. The most extreme tail risks lie on a potential run on governments which would destabilise the banking system, which has yet to recover from the 2008/9 bear mark.
Bull view
The bulls will see this fall in risk markets as a good buying opportunity, citing that in the current climate markets tend to exaggerate fears. This will look for a run higher in risk trades going into the New Year, especially in light of the stronger jobs numbers last week.
Bear view
The bears will cite the credit crunch as a prime example where market participants can lose confidence in debt structures causing a run on the “system”. If the fiscal debt crises spreads across other countries, we may see capital flights out of at risk countries plunging economies back into deep recession.
Futex view
We believe that the tail risks of global fiscal crises are too large to ignore. The most extreme scenarios may see governments, especially those of emerging economies begin to default on debt. This would expose investors globally. Also if developed nation economies are forced to remove fiscal stimulus from economies, markets that are fragile already may take a plunge.
