Does period of calm signify end of Eurozone crisis?

In a note out this week, Ted Scott, Director of Strategy at F&C, comments on the state of play in Eurozone government bond markets following this spring's sovereign debt crisis.

The note looks at the current situation in the Eurozone and asks whether conditions in the periphery countries (Greece, Spain, Portugal and Ireland and to a lesser extent Italy) have improved, and if investors should still be concerned about the size of the respective countries' budget deficits and gross debt.

Scott says that following the European Central Bank's €750bn bailout package in May, a measure of control has been achieved, as evidenced by the declining need for the ECB to purchase bonds. However, even though yields on the periphery countries' bonds are now below the peak levels they reached in June, they are still in many cases at record spreads over the safe-haven German bunds, as bund yields (along with UK and US government bond yields) have fallen on the back of fears of deflation and a double-dip recession.

"The fact that spreads have widened to the German bund is paradoxical because the German economy has been growing much faster than any analyst had forecast," says Scott. "It was believed that confidence and growth would be dragged down by the negative effect of the sovereign debt crisis. However, in the second quarter, German GDP rose by 3.7%."

Scott looks more closely at the Irish situation, which he says provides a cautionary tale for Eurozone sovereign debt investors. "The example of Ireland illustrates how hard it is for a country to reduce its national debt and fiscal deficit while not impairing its capacity to generate economic growth," he says. "For Greece and the other periphery nations this is a reality check and the experience of Ireland is something they can learn from."