Eurozone debt crisis not out of the woods yet
Right about now might be a good time to start worrying again about European peripheral debt.
Along with just about every other risk asset, the debt of the weaker members of the euro has sold off in recent weeks, hit by rising yields in higher-rated government bonds and a general pullback from bonds.
If markets regain their equilibrium, that's all it may turn out to be – a short sell-off in sympathy with global markets.
Arguably few markets, however, have as much to lose from an extended market downturn as bonds from Italy, Spain, Portugal and Greece, which have a number of structural and cyclical weak points which investors for the past 10 months have been mostly happy to ignore.
Ever since Mario Draghi made his famous "whatever it takes" statement about saving the euro, and the ECB unveiled its Outright Monetary Transmission (OMT) bond purchase programme, calm has returned to European markets, so much so that they have traded often times in an almost normal way, being driven by large forces outside their immediate purview, such as Fed policy.
That, in itself, is the definition of success of official policy, but it does not have to last forever.
"The benign European sovereign spread markets, prevalent since the ECB's OMT announcements last year, have enabled us to reassess some risks and forget others.
"It is fair to say that over time policy implementation and other events have had the effect of genuinely reducing risks or reducing the likely impact of risks being realised," UBS interest rate strategist Justin Knight wrote in a note to clients.
"However in some cases, risks are just as real as they always were, but will probably not concern us until and unless pressures come back to the European financial markets."
The state of the euro project has attached to it a long laundry list of unanswered fundamental and structural problems, each of which might conceivably send European peripheral debt sprawling should they capture the attention of investors once again.
None of this, of course, has to happen. Markets may repair themselves, the yen may weaken once again and in several weeks we could be just as oblivious to the risks of weaker eurozone debt as we were six or eight weeks ago. Still, even if the bogeymen never come out from beneath the bed, it is probably best to name and describe them so we can recognise them if they do.
As has become clear during hearings in the German Constitutional Court over ECB crisis measures, the OMT is not an unlimited potential source of financing for hurting euro zone governments.
The OMT, which is meant to buy bonds in the secondary market only after a country has applied for help and agreed to take remedial steps, is indeed limited in scope by practicalities, according to testimony before the court by Executive Board member Joerg Asmussen.
"We announced that our OMT interventions would be ex-ante 'unlimited'. We have no doubt that this strong signal was required in order to convince market participants of our seriousness and decisiveness in pursuing the objective of price stability," Asmussen said.
"At the same time, however, the design of OMT makes it clear to everyone that the programme is effectively limited, for one by the restriction to the shorter part of the yield curve and the resulting limited pool of bonds which may actually be purchased."
Limited and unlimited are two different things, and investors will work out the implications.
As well, as Knight points out, bond holders may grow concerned about where they stand in relation to official creditors.
Why hold a Spanish bond if you will only lose out to the ECB and other officials if the credit goes to the wall? Though much was done to damp down worries last year, the only true example we have is Greece, where private lenders suffered a haircut and euro public sector ones did not.
Or take the example of Cyprus, where bank depositors were forced to bear a portion of the costs of failing banks.
Despite this, by some measures deposit flight has actually decreased in the past year. Cyprus may have been a necessary step, but what we have not had is a bout of severe worry about a given eurozone nation.
It may well be that money does not flee under those circumstances, especially funds covered by the €100,000 deposit insurance plan.
On the other hand, even those covered by insurance might have cause to worry in the new post-Cyprus world.
With a bit of luck in global markets, eurozone officials may not have to worry about any of this.
If their luck does not hold, look for eurozone issues to climb back to the top of the global markets' agenda.