From time to time, Morningstar publishes articles from third-party contributors under the "Perspectives" banner.
Here, Arjun Parthasarathy of www.investorsareidiots.com, a financial website for investors, writes about the Euro-zone debt crisis and his view of markets.
If you are interested in Morningstar featuring your content, please find further details here.
The markets seem to believe that the debt crisis in the Eurozone, which rocked financial markets in 2011, is over.
Sovereign bond yields in indebted nations of Italy and Spain are sharply down from peaks seen in November 2011 while equity indices have rallied handsomely across the globe from November 2011 to date.
The rating downgrades of France, Italy and Spain by Standard & Poor’s, due to lack of credible fiscal consolidation measures, has had no impact on markets whatsoever.
The following tables show the movement in bond yields and equity markets over the last two months.
Bond yields in the Eurozone continued to fall post the rating downgrades, implying markets had already factored in the downgrades.
S&P downgraded France's credit rating by one notch to AA+, Italy's by two notches to BBB+ and Spain's rating two notches to A on the January 13, 2012.
The euro, meanwhile, has rallied by over 2% since the rating downgrades were announced, further reinforcing the market's belief that the debt crisis is passing over.
Is the debt crisis really over?
Obviously not. The fall in bond yields of Italy, Spain and France have nothing to do with the debt position of these countries. The fall in bond yields has everything to do with the European Central Bank.
The ECB has pledged to give unlimited amounts of money to banks in Europe in order to tide over a liquidity crunch. The ECB is lending three-year money at 1% to banks and banks are using this money to buy debt, which is yielding above 1% to arbitrage on the yield difference.
The auction of funds by the ECB in December 2011 saw banks borrowing $643 billion from the central bank.
Banks are now looking to earn from the money borrowed from the ECB. Short maturity bond yields of Germany and Denmark have gone below 0% as banks rushed for safe assets.
Banks are now buying bonds of countries where yields are attractive enough to earn arbitrage spreads and two-year and above bond yields of Italy, Spain, France and other indebted countries are giving attractive yields.
Hence the sharp fall in bond yields of indebted nations of the Eurozone.
The fall in bond yields, the rise in equity indices and the rally in the euro do not, for a moment, suggest that the debt crisis is over.
Italy, Spain and France have a long way to go before they can convince markets that their fiscal position is better. Italy's debt-to-GDP ratio at 119%, France and Spain's at 82% and 60%, respectively, are high given their extremely low growth outlook--Eurozone is expected to go into recession in 2012 as per the World Bank--and bringing down debt levels will not be an easy task.
If the crisis is not over, will the markets correct?
The debt crisis is not over but the current problem of rising bond yields is postponed with the ECB offering unlimited funds to banks in Europe. The fall in bond yields of indebted Eurozone countries is providing relief to the markets and this relief is driving up equity indices across the globe.
Markets are also looking towards China and India easing monetary policy as growth in these countries have come off with China's fourth-quarter GDP growth for 2011 coming in at 8.9%--a two-and-half-year low--while India's GDP is expected to slow down to 7% levels for 2011-12 from 8.6% levels seen in 2010-11.
China and India had tightened monetary policy in the last one and half years on rising inflation expectations. Easing monetary policy in China and India can boost demand in these countries leading to a growth in exports worldwide.
The markets will not correct significantly despite the sharp rally from November 2011 given the liquidity provided by the ECB, which will keep bond yields in check in the Eurozone and given the expectations of monetary easing in China and India, which will provide impetus to growth in these countries.
Equity markets will maintain a broad uptrend in 2012, thanks to the liquidity provided by central banks. The euro will be the funding currency of choice, given that the ECB will be the most aggressive in proving liquidity to the markets.