Europe Economy

Uncertainty Plagues Euro Zone as Crisis Rages On

Attempting to decipher what will happen next in the euro zone crisis following the annual meeting of the International Monetary Fund in Washington is no easy task.

Germany and Greece say there will be no default, while Tim Geithner says that “The threat of cascading default, bank runs and catastrophic risk must be taken off the table.”

George Soros told a meeting in Washington that the current crisis is more serious than the one that developed around the collapse of Lehman Brothers in 2008, and called for the creation of an EU Treasury.

Reports from papers such as London's Sunday Times talk of 3 trillion euros' worth of "shock and awe" measures aimed at defending the Italian and Spanish bond markets.

But in asign that bold action could have negative consequences, Standard & Poor's is warning that increasing the size of any bailout could endanger all the euro zone members' credit ratings.

With so much uncertainty in the air, even the most seasoned investor watching the ongoing euro crisis could be forgiven for wanting to crawl into a darkened room until it was all over, as the risk-off trade sees billions of euros and dollars lost, day after day.

“The weekend was characterized by claim and rebuttal, counter-claim and denial, Julian Pendock, chief investment officer at Senhouse Capital, told CNBC on Monday. He described the idea of a leveraged European Financial Stability Facility as the gearing up of "new debt to replace existing debt. It really is a CDO squared- and subprime at that — S&P has already fired another warning shot over Europe's bows, saying that it will lead to a downgrade."

With all 17 members of the euro zone having to agree on any measures put forward, the way out of the crisis is fraught with risks but is beginning to take form, according to Simon Derrick from Bank of New York Mellon.

“As expected, it looks as if there will be a managed default in Greece by the middle of next month," Derrick said. “Although Portugal and Ireland might be left to fend for themselves, there will be a determined effort to place a firewall around the European banking system and core nations such as Spain and Italy."

The selling of all kinds of assets looks very worrying as investors wait for some kind of resolution.

European stocks opened sharply lower on Monday, and stocks in Thailand ended the session nearly 8 percent lower in a sign that pressure in one area is now leading to huge volatility in other, formerly uncorrelated assets.

“Asset markets have again become very highly correlated, a pattern that carries with it a whiff of 2008, although the magnitude of the sell-off remains very small by comparison with those cataclysmic days,” said Michael Gavin, emerging market strategist at Barclays Capital, in a research note on Monday.

Gavin believes that at least some emerging market fund managers who cater for rich clients have been selling assets in order to raise cash in case investors take money out of their funds—actually inducing the very outflows managers had feared.

“For now, we remain more cautiously than opportunistically oriented, and not just for fear of 'catching the falling knife.' What is interesting, and to some extent ominous to us, is not the correlation, but the differentiation that we see in markets that are particularly close to the epicenter of current market concerns,” said Gavin.

That includes the underperformance of European stocks and both French and German debt versus US Treasurys.

“US (credit default swaps have) actually declined slightly—even though this period includes the very noisy and dispiriting stand-off over the US debt limit and the S&P downgrade,” said Gavin.