Reality set in on Friday and dragged stocks lower as investors weighed the significant challenges that still face Europe despite an important deal to cut Greece’s debt and prevent larger countries from falling down the same hole.
The retreat followed the euphoria, especially in European markets, that greeted Thursday’s agreement to greatly increase the firepower of the EU’s bailout fund and knock €100 billion off the amount owed by Greece.
Analysts were quick to raise questions about the lack of detail in the plan, and the euro and oil prices began pulling back on Friday. Stock markets were not far behind.
“Enthusiasm, so evident yesterday with the huge market rallies seen around the world, appears to have a taken a back seat to the question ‘How on earth is all of this going to work?’” said Jennifer Lee of BMO Capital Markets. “The details, or the implementation of the grand plan, will be extremely difficult to carry out”.
Of particular concern is exactly how the bailout fund’s new powers will work. The hope is that by using the €440 billion European Financial Stability Facility to insure against some losses on the bonds of wobbly countries like Italy and Spain, Europe will be able to avoid ever having to mount a rescue again.
A first test of how much this has reassured investors came on Friday – and the marks were not great. In a bond auction, Italy saw its borrowing rates rise to six per cent from 5.86 per cent in a similar debt sale a month ago. With Italy’s yields rising, the fear is that it might eventually be unable to afford to borrow from markets, as Greece is.
“It is all too obvious that the outlook for Italian bond yields is closely intertwined with the fate of EMU (European Monetary Union),” said Jane Foley, an analyst with Rabobank. “If Italian bond yields can be contained, the chances that EMU can continue to stumble forward are good. If not, the outlook is dire.”
Also, although the deal threw a lifeline to Greece, it asks banks to shoulder much of the cost by accepting losses of 50 per cent on the Greek bonds they hold. Many of the continent’s banks are already struggling with tighter access to the loans they need to run their day-to-day operations, and the prospect of substantial losses could further weaken them.
Markets began to absorb the scepticism on Friday. The UK’s FTSE 100 closed 0.2 per cent lower at 5,702.24. The German DAX eked out a 0.1 per cent rise to 6,346.19 but France’s CAC-40 fell 0.6 per cent to 3,348.63.
The euro pulled back after a meteoric rise in the hours after the deal was agreed. It was down 0.2 per cent to $1.4163 on Friday.
Wall Street also opened lower. The Dow Jones industrial average fell 0.1 per cent to 12,194.40 and the broader Standard & Poor’s 500 index slipped 0.3 per cent lower to 1,280.27.
Earlier in Asia, stocks were still riding the bump from the deal. Japan’s Nikkei 225 index rose 1.4 per cent to close at 9,050.47, its highest close since 1 September. Hong Kong’s Hang Seng gained 1.7 per cent to 20,019.24 and South Korea’s Kospi rose 0.4 per cent to 1,929.48.
Australia’s S&P/ASX 200 gained 0.1 per cent to 4,353.30 and the Shanghai Composite Index added 1.6 per cent to 2,473.41. Benchmarks in Singapore, Taiwan, Indonesia and Thailand were also higher.
Amid the renewed doubt about Europe’s debt crisis, concerns about the global economy were back as well, pushing oil prices lower.
Benchmark crude for December delivery was down 75 cents at $93.21 a barrel in electronic trading on the New York Mercantile Exchange and Brent crude was down $1.91 at $110.17 a barrel on the ICE Futures Exchange in London.