Europe's debt problems, pushed into the background by an American-style central bank liquidity surge, have come back to revisit the markets, perhaps sooner than many investors had expected.
When the European Central Bank last year launched an aggressive round of Long-Term Refinancing Operations to stave off the sovereign debt problems, markets rejoiced that issues with Greece, Portugal and others on the euro zone periphery had been stanched.
But yields have been rising again recently, and investors are coming to grips with the idea that hopes for a shallow European recession may have been ill-founded.
"If the periphery's credit crunch continues, the region's recession could be deeper and its recovery prospects weaker than market expectations," Athanasios Vamvakidis, forex strategist at Bank of America Merrill Lynch, told clients.
One of the main problems is that the ECB's maneuvering has resembled its U.S. counterpart — the Federal Reserve — in more ways than one.
While the LTRO capital injections have helped steady banks that held the sovereign debt , the banks in turn are not lending that money back into the marketplace, compounding the continent's economic slowdown.
"While the size of this facility provided a much needed boost in confidence, it has not yet resulted in a significant improvement in credit availability to borrowers in the EU.," said a report from Sean Lynch, global investment strategist, and Peter Mangus, managing director of equity research and strategy, at Wells Fargo.
The two recently did a canvassing tour of financial professionals in London and Frankfurt and found significant concern about the likely temporary fix that the LTRO brought the markets.
"Instead of increasing lending, many of these institutions have used this funding in 'carry trades,' taking the money and using it to purchase longer-term sovereign debts yielding more than the cheap financing offered by the ECB at 1 percent," Lynch and Mangus wrote. "This strategy has had a positive effect on interest rates, as sovereign yields have come down due to the institutional buying, but has not freed up lending to the extent that the ECB had hoped."
Investors remain concerned about many of the European nations, Spain in particular.
Here's a rundown, by country, of the main worries European investors have about the countries at the center of the debt crisis, according to Lynch and Mangus:
- Spain: A brutal debt load makes the country the primary euro concern. Underperforming real estate loans are hammering banks, while 23 percent unemployment restricts growth. None of the financial professionals expect Spain to default, but "the challenges the country faces are serious."
- France: Few if any credit concerns, even though it has suffered a downgrade. Worries are more political.
- Italy: Considered "a model of reform," the country nonetheless is facing a 1.5 percent decline in gross domestic product, attributable largely to austerity measures.
- Portugal: Its willingness to reform scores points with investors, but "the impact of a default in Portugal would have far-reaching implications for the euro zone."
- Ireland: "Not in the crosshairs" of worry, though investors fear whether slow growth and underperforming loans will undermine reform efforts.
- Greece: Facing "enormous and extremely complex problems," investors anticipate another round of restructuring that "could see a replay of the high drama" from last year's restructuring.
- Germany: The most solid of all euro-zone countries, investors worry only that pre-emptive austerity measures could slow growth.
Overall, European investors remain concerned that the debt crisis won't simmer for much longer.
"The mood among the investors and industry specialists we met during this trip was particularly somber," Lynch and Mangus said. "We suppose that the heightened tension associated with the sovereign debt crisis has taken its toll on this group, much like it has for investors around the globe."
Indeed, such worries have investment pros closer to home taking money off the table, Wednesday's stock marketrebound notwithstanding.
"If they can keep Spain stable, our markets will do much better," say Philip Silverman, managing partner and portfolio manager at Kingsview Management in New York. "But if there starts to be panic, you have a whole other level of intensity for the crisis."
Silverman is advising clients to "take a step back" and collect gains they hopefully realized from the rally that began in October.
Julian Jessop, chief global economist at Capital Economics in London, also thinks investors may have underestimated the European debt situation. Capital is forecasting a full-year level of 1,350 for the Standard & Poor's 500 — below the level it registered in Wednesday trading.
"There should also be plenty of volatility along the way, triggered in particular by a further escalation of the crisis in the euro zone (which) could be about to enter a whole new phase, ultimately leading to the breakup of the currency union itself," Jessop said in a note.
Still, some think that the market already should have priced in Europe's debt woes.
"They've proven that they're basically going to come in and be the backstop, to play fireman with a bucket of water to throw on any fire," Michael Cohn, chief market strategist at Global Arena Investment Management in New York, said of central bankers. "It's always the stuff you don't know that really throws the market for a loop."