Once Again, Investors Are Saying Europe Is The Biggest Risk To The Markets

The fiscal cliff has taken top billing in the “main risks” sections of investment forecasts and economic outlooks for the past several months as markets awaited the December 31 showdown over spending cuts and tax hikes feared to put a serious drag on the economy.

Concurrently, since the ECB’s announcement of an OMT bond market intervention plan to combat rising borrowing costs this summer, unsustainably high interest rates have been fixed on a steady downward trajectory in Europe, and the euro crisis has captured less and less attention.

Politicians averted the fiscal cliff by making a deal to postpone it, but there are still three big fiscal battles taking place over the coming weeks and months: there is, of course, the debt ceiling, there are the automatic spending cuts in the sequester postponed by the cliff deal, and then there is the expiry of the “continuing resolution,” which would lead to a government shutdown if not renewed.

However, investors are once again – for the first time since early last summer – citing Europe as the biggest risk to financial markets, according to a BofA investor survey of 86 global fixed income fund managers conducted between January 4 and January 9.

Specifically, deterioration in the fundamentals of the European economy now poses the biggest threat:

European fundamentals market risk bofa survey

Photo: BofA Merrill Lynch

Concerns stemming from the fiscal cliff remain high at 31 per cent, but they have come down in January as the European story has returned to investors’ minds.

Investors may feel more comfortable with the U.S. fiscal situation due to recent trends in the economic data, according to the survey:

Bofa survey fiscal cliff housing recovery energy

Photo: BofA Merrill Lynch

As ECB President Mario Draghi recently noted, financial conditions in the eurozone are on the mend, but much of the economy is not. Further complicating matters are that policymakers already have too high of expectations for economic growth, forcing them to continually revise their projections downward.

Deutsche Bank strategist Jim Reid devoted a large portion of his 2013 outlook to the topic of eurozone economic fundamentals. This excerpt sums up the concerns pretty well:

In 2012 the ECB prevented a financial meltdown by announcing its intention to buy short-dated bonds for countries in need via the OMT program. This is a huge step from the ECB but it remains a liquidity facility and not a solution to any solvency concerns that there may be in the future. For it to work successfully over the medium-term it needs to be proved that growth can stabilise in the most vulnerable countries and then show signs of picking up.

If we see some indication of this in 2013 then the European Sovereign crisis will continue to be on hold. However our fear is that if economists again under-estimate the negative growth consequences of this crisis and indeed austerity in the most vulnerable countries, then it’s possible we can have solvency concerns reasserting themselves even though a liquidity program is operational.

We noted a month ago that things have really changed when a European bank analyst is mostly worried about the U.S. economy – but perhaps things haven’t changed so much, after all.

SEE ALSO: The European Bailout That Everyone Forgot About Is Running Into Trouble >

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