Political upheaval is ushering in a change of focus for the euro zone, according to Paul Brain, manager of the Newton Global Dynamic Bond Fund.
He said: "As we enter another round of anxiety regarding the euro zone, should we be more concerned this time?" asks Brain, "In some respects, the answer is ‘yes', as the economic situation seems to have worsened, and is now even affecting the core Northern European economies. On the other hand, the European Central Bank has adapted to address the new developments, and is more willing to provide the liquidity required to keep the financial system going."
Changing of the guard?
"The 'firewall' contingency planners have more funds at their disposal," Brain said. "Our contention has been that all these resources may not be sufficient if some of the larger peripheral economies, namely Spain and Italy, were unable to maintain positive nominal GDP growth.
"The deficits of these countries would rise, and the primary question would be one of solvency, rather than liquidity. On the other hand, the good news emanating from a deterioration in the growth outlook for the Northern European economies is that it brings the reality of the situation home to the countries that have been advocating a 'fiscal austerity only' stance.
"Just recently, German Chancellor Merkel suggested that Europe required a more pro-growth stance, the French electorate has voted in a ‘pro-growth' President in the form of Francois Hollande, while the recent Dutch government collapse suggests that the 'fiscal hawks' (Germany, Finland and Holland) may also change their tunes.
"Meanwhile, the change in sentiment within the Greek population highlights why a prolonged and severe fiscal austerity approach can ultimately lead to a change in government and then rejection of that approach. We believe that the biggest risk remains Greece leaving or being ejected from the euro zone, sparking contagion throughout the region.
"There remains the question as to what can actually be done to solve the region's problems but at least there are signs that the policy of single-minded fiscal austerity is being challenged.
"In the meantime, we expect that Europe will continue to meander towards a crisis before a response is given by the ECB (possibly in the form of an interest-rate cut, followed by another round of Long Term Refinancing Operation 'LTRO' monies).
"In the process, 'safe-haven' bond market yields would likely drop even further and perhaps we may even see German bond yields as low as the sub-1% Swiss or Japanese yields."