This time, it was the Americans who finally got their act together. The U.S. Congress managed to avoid the “fiscal cliff” and agreed to a limit on tax hikes.
European markets cheered the move, but issues remain.
The EURO STOXX benchmark index went up 3.9 percent to close at 2,709, one of the best weekly rallies in recent months. The Euro, however, lost 1.1 percent to close at 1.3069 after having enjoyed a steep rally to $1.33 the weeks before.
Stocks likely benefited from the relatively benign resolution of the U.S. “fiscal cliff”. A full enactment of spending cuts and tax hikes would have hurt European exporters. Apart from some profit taking, the euro likely suffered for two reasons.
Risks surrounding the United States have been reduced, which makes the euro less attractive as a “safe-haven” for investors. Secondly, European companies which were shoring up cash at home to prepare for a full fiscal cliff impact have likely stopped buying back euros.
Greece Risk Postponed but Plenty of Issues Remain
European stocks and the euro did enjoy a decent rally heading into the year end. The Greek reckoning has been postponed once again, although markets are still waiting for a sustainable solution. Creditors, including the International Monetary Fund and the European Union, agreed to reduce interest rates and lower the debt burden through a debt buy-back in November 2012.
While debt and debt service has been reduced at the sovereign level, the ailing banking sector is suffering from an exponential growth in delinquent loans. The total amount of so-called non-performing-loans, or loans that have missed several payments, has risen over 50 percent since December 2011.
Non-performing loans now make up 24 percent of the total loan book of Greek banks and stand at $72.5 billion.
Spain on the other hand has had difficulty selling its bonds to private investors and has tapped its public pension fund to purchase bonds. According to the Wall Street Journal, the country already spent 90 percent of its $85.7 billion fund to purchase its own sovereign debt.
This procedure became common practice in the United States after it breached the statutory debt ceiling in 2011. The Department of the Treasury under Secretary Tim Geithner used public pension funds and other entities to purchase debt from the Treasury, thereby avoiding further debt sales to the public.
Even if things in Europe appear to be reasonably calm, you can be certain that at least one country will manage to stoke a fire.
In this week’s case, it was France’s millionaire tax, which provided the upset. The socialist government under President Francois Hollande legislated a tax of 75 percent on incomes higher than one million euros or $1.31 million.
Despite the fact that the constitutional court dismissed the legislation as unconstitutional, several rich and famous French people announced that they would emigrate to escape the tax.
The most prominent example is perhaps the actor Gérard Depardieu (Obelix). He was welcomed as a Russian citizen by President Vladimir Putin last week in Sochi. Depardieu voted with his feet and renounced his French citizenship to take advantage of the 13 percent flat tax rate for individuals in Russia.
It is true that the economic impact of a few French millionaires leaving the country is negligible. However, the ramifications of a decidedly anti entrepreneurial stance could be devastating for the country that this year hopes to achieve GDP growth of 0.8 percent and running a budget deficit of 3.5 percent.
The Week Ahead
This week will see the first meeting of the European Central Bank in 2013.
Analysts do not expect any material policy changes, but the strong rally in European equity markets might suggest otherwise. In recent years, markets have always rallied strongly before central bank easing disregarding analysts’ forecasts.
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