CHICAGO – Europe has been experiencing a period of calm after the storm since European Central Bank President Mario Draghi’s “whatever it takes” speech in July and the ECB’s decision in September to proceed with its “outright monetary transactions” (OMT) program to purchase distressed eurozone members’ government bonds. The interest-rate spreads for Italian and Spanish government bonds have dropped dramatically, corporate-bond issues have resumed, and a sense of normalcy is slowly pervading the continent.
But it would be foolish to conclude that the euro’s problems have been solved. The economic fundamentals are far from stable, while the reduced financial tension is the fortunate outcome of an expectation game. As long as investors believe that Italy and Spain will eventually be rescued by the OMT, these countries’ borrowing costs will be low, and the rescue will not be needed. If, however, the slightest doubt about the OMT’s effectiveness arises, the expectation game will shift into reverse, and both countries’ bonds will quickly come under attack.