Europe’s policy credibility is at stake as the market consistently provides clearer feedback to policymakers on their perceived successes and failures, Arnaud de Servigny, the head of research analytics at Barclays Wealth, said.
“European governments now have to prove that they are able to better coordinate fiscal policies, to adjust liabilities related to the welfare state and to provide flexible support for private entrepreneurship,” de Servigny wrote in a research note to clients.
Following huge market volatility in May following the €750 billion ($922.5 billion) rescue package for the European bond market and big new European Central Bank intervention, policymakers need to regain credibility, he said.
“Proving their competence will take time, the transition period will be costly in terms of growth, but cannot be delayed any further," he said. "Credibility is at stake.”
Market Verdict on US Positive
The US is being viewed as a safe haven because the market is taking its policy response to the financial crisis seriously, de Servigny said.
“The US government is acting decisively to maintain its credibility." Financial reform is one area where de Servigny said he believes the market is taking US policymakers seriously, while a return to growth and the relative resilience of private consumption are other policy successes.
“Overall, the market’s verdict is that the US is turning out to be a relative safe haven and this is translating into dollar strength despite high public debt and deficit levels,” he wrote.
With uncertainty and volatility so high, investors should be "cautiously optimistic," but partially mitigating downside risks, de Servigny said.
“We favor geographical diversification while stressing the importance of keeping a long-term investment horizon and not acting precipitately on short term worries.”
Barclays Wealth is more bullish than some houses and predicts a benign market scenario remains a more likely outcome than some of the more bearish calls out there at the moment.
“Investors should hold a full complement of risk assets but all portfolios should contain some investments that will do well if the recovery falters,” de Servigny said.