MORGAN STANLEY: Europe Will Get Worse

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Earlier today, Citi’s Chief Economist Willem Buiter published a research note in which he raised the odds of a Greek exit from the eurozone to 90 per cent.Morgan Stanley’s Global Cross-Asset Strategy Team led by Greg Peters is also worried about a Greek exit from the euro.  They’re also concerned about Spain, which is getting worse and is also much bigger than Greece.

From their latest note to clients:

Stress has returned to Europe, but the stakes are higher. Spain (let alone Italy) is not Greece: its economic size, the cost of a rescue, and the increased market scepticism about temporary fixes suggest that the policy response needs to include some of the political and institutional reforms that prior crises have not changed.

Conditions will likely worsen in the near term. Rating agencies have put investors on notice about further potential downgrades (not just to sovereigns, but also the European Financial Stability Facility, EFSF); Spain is struggling to maintain access to markets; and the price action is becoming disorderly. Our colleagues in Europe are not convinced that support from the EFSF (or the European Stability Mechanism, ESM) would be effective. Ending the cycle of crises requires concrete steps to fiscal union and the ECB to act as a sovereign backstop, as the Fed does for the US Treasury. These may come, but the crisis might have to intensify first. Aggressive ECB action, were it to come, could spark a material rally. If it does not come, then we may be nearing a messy Eurozone divorce scenario.

The EFSF and ESM are bailout funds from which debt-laden countries like Spain are expected to borrow cheaply.  However, should these funds get downgraded, the cost of those bailout funds would likely go up.

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