Estimates state that the Italian banking system is holding around €360 billion of non-performing loans and if banks were required to write down these loans to current market values the Italian banking system could be required to raise up to €40 billion of new capital. The issue is that the most vulnerable banks are not able to raise new capital and the Italian Government is not able to provide financial assistance to bail out a bank under new EU rules until private sector creditors, accounting for 8% of the bank’s liabilities, have been forced to convert to equity. The junior debt which is first in line to be bailed in is largely held by retail investors. The risk is that a large bail in of retail bonds could trigger a depositors run on the Italian banks. There may well be more market volatility ahead. Read the full article for Hamish Douglass' view on Europe.
Real GDP growth in the eurozone has improved, but remains modest (around 1.6% p.a. in aggregate since December 2014). The periphery economies of Spain and Ireland are bouncing back with growth of 3.5% and 9.3% p.a. respectively, following deep recessions. Meanwhile, Greece’s economy has stagnated. The eurozone as a whole is likely to continue benefiting from a weaker currency, a stronger US economy, lower commodity prices, and an improvement in borrowing conditions and credit flows in an environment of ultra-low interest rates. However, the pace of eurozone growth is likely to remain modest for the foreseeable future as high levels of government debt, unresolved banking system issues, political impediments, uncertainty created by the Brexit vote and an emerging markets slowdown hold back the economy.
Labour markets are gradually recovering in the eurozone, although considerable slack remains. Aggregate employment increased 3.8 million to 152.6 million from June 2013 to April 2016, but remains below the pre-GFC peak of 154.4 million. Meanwhile, the aggregate unemployment rate has fallen from 12.1% in June 2013 to 10.2% in March 2016. Over the past year the unemployment rate has fallen in Germany, France, Portugal, Ireland, Greece, Italy and Spain.
The rise of Eurosceptic political parties in a number of eurozone countries reflects a long period of adjustment following deep recessions and accompanying high levels of unemployment, which has created difficult policy choices for governments. These parties often threaten an exit from the eurozone (and a dispensing of the euro as currency) and/or debt defaults, which could spark renewed uncertainty in sovereign debt markets.
The combined effects of high debt levels, labour market rigidities and unfavourable demographics are likely to present ongoing headwinds for growth.
The eurozone also remains vulnerable to major shocks, such as an escalation of geopolitical tensions with Russia, the election of Eurosceptic governments or a collapse in the renminbi. Each of these scenarios could trigger a dramatic uplift in periphery eurozone sovereign bond yields, and would heavily test the resolve and mandate of the ECB.
Contributed by Hamish Douglass, CEO of Magellan Financial Group: (VIEW LINK)
Magellan was formed in 2006 by Hamish Douglass and Chris Mackay, two of Australia’s leading investment professionals. The company specialises in global equity and listed infrastructure assets.