An expected bailout of the Irish government and its moribund banking system has done little to quell bond managers' uneasiness about risks in the European periphery, and bond managers view the Irish problem as a mere distraction from the main event: Spain.
As a result of the crisis, European bond managers are shunning investments in the peripheral nations or making very limited, opportunistic bets on bonds of individual countries or companies.
“(An Irish bailout) doesn't really draw a line under the whole peripheral crisis,” said Richard Dryer, head of EMEA credit at Aberdeen Asset Managers Ltd., London. “In reality, the next big issue is Spain.”
“(Spain) causes us a greater loss of sleep” than other peripheral European countries, agreed Ralph Frank, head of solutions for investment consultant and discretionary manager Cardano Risk Management BV, London.
Spain is important because of the size of its economy, which towers over the fellow peripheral countries of Portugal, Ireland, Italy and Greece.
The European Financial Stability Fund — a €750 billion ($974 billion) safety net set up by the European Union and International Monetary Fund in May — can prop up Greece, Ireland and Portugal, but a sinking Spain is widely thought to be too big for the fund to rescue.
While bond managers and economists view the European debt crisis as far from over, the good news is that Spain looks relatively healthy, unencumbered by the policy shortcomings of Greece, the oversized banking sector debts of Ireland and the dismal economic growth of Portugal.
“Spain is doing everything it should, and it doesn't start from as bad a position as Ireland ... or Greece,” said Jacob Funk Kirke-gaard, research fellow at the Peterson Institute for International Economics, Washington. “So, I'm pretty optimistic.”
The Spanish government has been aggressive on fiscal tightening and structural reforms, and Spain is increasingly less dependent on foreign financing, Willem Verhagen, senior economist at ING Investment Management, The Hague, Netherlands, said in an e-mailed response to questions.
Plus, Spain's “banking sector has made some real progress. ... Exposure to property developers and construction companies has been reduced severely while, contrary to Ireland and Portugal, dependence on (European Central Bank) financing has fallen since early summer,” Mr. Verhagen noted.