German Economy Booms, Portugal Bond Auction Succeeds

The eurozone got some good news this morning, suggesting that the economies there are not going to be the victims of bond market vigilantes for a few trading sessions at least. The German government announced that its economy grew at its fastest rate in two decades. Elsewhere, the Financial Times reported, "The most closely watched government bond auction of the year to date saw Lisbon sell € 1.25bn of four-year and 10-year bonds. It was the maximum amount that debt managers were looking to sell and demand was strong." Thanks to globalization, both facts are good news for the rest of the world.

The German government said GDP grew at a rate of 3.6% last year when adjusted for inflation. In 2009, the German economy contracted 4.7%. Germany is the second largest exporter in the world, recently surpassed by China that has more than 15 times Germany's population. Germany, with the support of the French economy, is the main engine of growth in Europe, so when Germany does well, there are ripple effects throughout Europe. However, some have worried that Germany's exports are purchased by other Europeans on credit, enhancing the debt bomb there. On that front, household spending in Germany rose 0.5%, which helps rebalance the trade relationships.

Over in Portugal, not only did the government fully sell out its allocation of bonds, but also the bonds' yield was 6.71%. That is significantly below the 7% threshold at which the Portuguese government says debt servicing would become unsustainable. That rate is also 90 basis points lower than the yield from the November 10 auction. On the 10-year bond, the issue was over-subscribed by 3.2 times; the November 10 auction was over-subscribed by only 2.1 times. The market is starting to view Portuguese debt as a less risky proposition.

That raises the question "why?" Part of the reason is that the Portuguese government is doing what the bond market wants. It is putting up taxes and dropping spending. That reduces the supply of debt, and therefore, raises the value of the debt that is issued. When bond prices rise, the yield drops.

However, it is not solely the fiscal rectitude that Lisbon has recently employed that has the bond traders sitting up and taking notice. The European Central Bank has intervened in the market to help the Lisbon gang out. Rumors of a bail-out are all over the place, but the facts seem to suggest that the ECB presence is enough, for now, to avoid that. Moreover, if there is a bail-out, the market figures that would draw a line under the Portuguese situation. The market likes certainty of that sort. Besides, Portugal is not in the dire situation that Greece and Ireland are, although without significant growth (2-3% would do), the country's debts remain something of a worry for the market.

Naturally, two data points don't make a trend, and Italy and Spain are selling debt tomorrow. A poor result for either of those would return market sentiment to negative. Indeed, some have not ever abandoned it. ECB council member Axel Weber said yesterday in Frankfurt, "The optimism of some observers seems premature to me." This journal doesn't believe Europe is out of the woods yet either, but one can't ignore the fact that the latest news is positive.

© Copyright 2011 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Ubuntu Linux.

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