Concerns for the health of European banks took center stage for global financial markets Wednesday, as hopes rose that eurozone nations would agree on a support package for the ailing Spanish banking system.
The financial markets, however, have been roiled in recent weeks by concerns over the fate of Europe’s currency union — with more downward pressure than uplift for share prices. It remains to be seen how Spain‘s crisis will be resolved, and a volatile Greek election is less than two weeks away.
Nations including Greece and Spain face a combination of high unemployment and debt-induced austerity. The risk of a messy breakup of the eurozone, with one or more nations exiting, has weighed on stock prices even in the US and other nations outside Europe.
On Wednesday, the positive expectations of a bailout for Spain were accompanied by new reminders of the risks if things don’t go well. Six German banks saw their safety ratings downgraded by a prominent credit-rating firm — a sign that Europe’s debt crisis affects even the largest economies.
In economic and fiscal terms, Germany is viewed as Europe’s strongest major nation. But the credit scores of German banks are merely in the middle to lower tier, compared with other European banks. That’s a sign of how these banks have loan portfolios that stretch beyond German borders, and of how eurozone economies are intertwined in their economic fortunes.
“Today’s rating actions are driven by the increased risk of further shocks emanating from the euro area debt crisis,” Moody’s said in a statement.
Moody’s said the loan quality of the banks carries “downside risks” from the debt crisis and a potentially weaker global economy. Meanwhile, Moody’s said the banks have a “comparatively small” amount of equity capital, the cushion available to absorb losses. That capital “could diminish in a stress scenario,” the firm said in its statement.
On June 17, Greek voters will elect a new Parliament, in elections that could potentially set the nation on course for falling out of the eurozone and defaulting on its debt.
Whatever the outcome of the elections, eurozone members appear set to face crucial tests of their resolve in the weeks and months ahead.
Some economists believe the currency union, with its disparate cultures and nations of differing fiscal health, is bound for eventual breakup, whether or not Greece becomes the first to go. Others argue the benefits of the common currency region provide a powerful incentive for the nations to hold together.
Economists at the International Monetary Fund recently described a scenario Europe must try to avoid: “a bad equilibrium of rising [interest rates], a funding squeeze for domestic banks, and a worsening economy.”
Such a negative outcome in the 17-nation eurozone would have implications far beyond Europe, potentially dragging the US economy near or into recession.
But as Wednesday’s market upswing showed, investors also see the possibility of more upbeat outcomes in Europe.
European efforts to prepare a Spanish rescue come alongside other signs of policy engagement. Eurozone leaders are considering possible steps such as issuing collective “eurobonds,” in a sign of determination to hold the currency union together.
Investors on Wednesday were also digesting headlines about possible new monetary easing from major central banks. Until recently, the US Federal Reserve has shown reluctance to make new stimulus efforts. But a weak monthly jobs report in the US, coupled with the global risk posed by an expected recession in Europe, may be opening the door to more “quantitative easing” of monetary policy.