World stock markets rallied on Tuesday with expectations that euro zone officials were close to developing further strategic moves in order to combat the crisis that has plummeted European economies. Despite the lack of commitment by Dutch and Finnish officials for a euro-area bailout find, the rally in stock markets still continued.
Not only did Asian stocks rebound from their lowest levels since May 2010, European and US stocks also rallied. On Wall Street, the Dow jumped 2.53 percent; the S&P 500 added 2.33 percent and the Nasdaq Composite rose 1.35 percent. In Europe, London’s FTSE-100 gained 0.45 percent, the Paris CAC 40 added 1.75 percent and Frankfurt’s DAX was 2.87 percent up (AFP). After three sessions of swings on the commodities markets, oil, copper, gold and silver all rose. U.S. crude jumped nearly $2 a barrel. In addition, the US dollar, US Treasuries and Japanese government bonds all eased.
In a meeting which is to take place within the ECB on October 6th, finance officials are likely to debate restarting covered-bond purchases and may discuss interest-rate cuts in order to ease the funding strains. Further adding to the speculation is that France is expected to draft plans to re-capitalise the country’s over-exposed banks. Senior ECB officials have also indicated that the 440 billion euro bailout fund is likely to be increased in size.
The euro-zone is coming under increasing pressure to resolve its growing debt problems as the US, China and other nations urge further action within the region. In an interview with ABC’s “World News with Diane Sawyer” program, the U.S. Treasury Secretary Timothy F. Geithner mentioned that Europe’s crisis is “starting to hurt growth everywhere, in countries as far away as China, Brazil and India, Korea. And they heard the same message from us they heard from everybody else, which is it’s time to move.”
Major market players still insist that the markets are as turbulent as ever. Markets still lack the confidence and are thus highly susceptible to contagion. Fears still loom over a double crisis with the expectation of a renewed recession in the US and the ongoing euro-zone crisis. This has caused the euro to exhibit volatile swings over the past months. The IMF has warned that the global economy had “entered a dangerous phase, calling for exceptional vigilance, coordination and readiness to take bold action” to cope with Europe’s unstable financial situation.
In a move that is expected to send shockwaves throughout world markets and particularly through the euro zone, Standard and Poor’s (S&P), the credit rating agency, downgraded Italy’s long-term credit rating to A from A-plus and cut its short-term rating to A-1 from A-1-plus with a negative outlook. The downgrade caught the financial world by surprise as a credit rating was primarily expected from the rating agency Moody’s which had announced last week that it had put Italy’s credit rating under review.
S&P’s sighted ‘political’ and ‘debt’ scores as the primary reason for the downgrade as per the agency’s sovereign ratings criteria. Furthermore, the agency’s rating reflected the view that the ‘fragile governing coalition and policy differences within parliament will likely continue to limit the government’s ability to respond decisively to the challenging domestic and external macroeconomic environment.’
Measures adopted by the Italian government, particularly the fiscal austerity program and tightening financial conditions have been rejected by S&P as reliable conditions for the rebounding of economic performance. The rating agency outlines three main reasons for their reduced expectations for the growth of the Italian economy: ‘low labor participation rates and tightly regulated labor and services markets; what we consider to be an inefficient public sector; and relatively modest foreign investment inflows.’ S&P also stated that it has lowered its outlook for Italy’s annual average growth to 0.7 percent for 2011 to 2014, from a prior projection of 1.3 percent.
Borrowing costs are predicted to rise for the Italian economy. A scenario as such would further cause the situation to deteriorate as the nation is about to initiate a refinancing program of nearly 30 billion euros (USD 41.3 billion) of gross bond issuance in October and November, according to Boris Schlossberg, director of currency research at GFT. A bailout for Italy would drain the euro zone’s resources placing the entire region in turmoil. In addition, the fear of contagion is becoming clearly visible as the anticipation of a Greek default on French banks is continuing to rise.
The IMF has stressed the need for Europe ‘to get its act together’ and work towards resolving the debt crisis. Furthermore, the IMF warns that if a proper road map for recovery is not planned and executed, global expansion will be at stake and these economies could ‘tip back into recession.’
All eyes are on Italy. Moody’s put the country’s sovereign rating on review for a conclusion as the ninety day review period drew to a close this week. The country is the latest in the set of unstable countries located within the euro zone to have its rating succumbed to a possible downgrade.
According to the rating agency, the country’s Aa2 debt rating was to be reviewed due to an “increasingly challenging economic and financial environment and fluid political developments in the euro area”. Italy, the third largest country in the euro zone, is burdened with a debt level of 1.9 trillion euros (USD 2.59 trillion). Italian debt currently exceeds that of Spain, Greece, Ireland and Portugal combined. As a result, the debt is vulnerable to any further increases in yields upon refinancing of its maturing debt. Its debt levels are currently at an all time high and equivalent to 120 percent of the county’s GDP. Currently, Italian debt accounts for 23% of the euro zone’s sovereign debt, which has the ECB’s alarm bells ringing.
In an effort to stabilize current conditions, Prime Minister Silvio Berlusconi announced a 54 billion euro (USD 74.5 billion) austerity package along with budget cuts this month in order to convince the ECB to purchase Italian bonds after borrowing costs surged to a peak in August with the 10- year yield reaching a euro-era record 6.4 percent. Despite the ECB having spent more than 60 billion euros (USD 83 billion) towards buying euro-region debt, Italy’s 10-year yield is again approaching 6 percent.
China has reportedly shown interest in easing the Italian debt-ridden nation from this crisis. Although it is not certain how much Italian debt the Chinese government intends to buy, Wu Xiaoling, a former deputy governor of the People’s Bank of China, has mentioned that helping Italy would be positive for both China and the world. The Chinese government has previously purchased USD$ 500 million of Spanish debt and has pledged to purchase Greek debt. With holdings of USD$ 3.2 trillion in reserves, China is currently being viewed as the worlds’ probable new ‘lender of last resort’. Furthermore, China is vulnerable to an unstable US economy as it holds over US$ 1.2 trillion in downgraded US treasuries. An effort to diversify the Chinese foreign investments can be evidenced from the country’s stance towards these recent interests in the euro zone countries.
A downgrade for the Italian debt would give rise to a perplex situation for Italian financial industry as the country faces surging debt levels and a stagnant economy. In addition, the prime minister currently has to undergo four major trials, which could bring the leadership of the country at stake. With all these events intertwined, the mood appears to be bleak for the Italian economy and the coming days will further confirm the economic reality that is prevalent within the euro zone.