Despite agreement over European debt, concerns remain


January 4, 2012

 

While member nations did agree to debt reduction measures at the summit of the European Union last week, continued questions and uncertainty remain ever-present as the credit ratings of all European countries appear in jeopardy.

During the summit, member nations agreed to enact stronger deficit rules to reduce macroeconomic risk, while also putting additional monies into a bailout fund run by the International Monetary Fund.

However, following the meeting, Moody's Investors Service said that the capital markets remain "critical and volatile," adding that there were very few new ideas on how to reduce debt presented at the meeting. The firm will finish a review of all debt linked to European nations during the first quarter of next year.

In addition, Standard & Poor's has already put a negative alert on the AAA credit ratings of 15 of 17 euro nations.

"It remains to be seen whether national parliaments will fully swallow this loss of sovereignty. If credible this fiscal compact should lead to a massive improvement in the rating of sovereign debt in the euro area," Daniel Gros, the Director of the Centre for European Policy Studies, told CNN. "A first test might come soon, when the ratings agencies have to decide whether to follow through on downgrade warnings issued before the summit."

Gros says at this point, just two countries would meet the terms of the deal, and many may face significant conflict when the depth of the required changes sinks in.

If the situation in Europe continues to show signs of instability, or the region's credit is downgraded, the tenuous situation would continue to have a trickle-down effect on economies across the globe.

In financial planning terms, continued issues across the pond could lead the Federal Reserve to make yet another round of Treasury purchases despite the potential inflation risk, which would continue to depress bond yields, reduce borrowing costs further and make some investment funds more attractive.

However, the housing market has been reluctant to respond to even the record-low rates which have been present for the last several months, so it's unclear what wide-reaching impact such a move would make. The Federal Reserve has already taken the unprecedented step of saying it will keep the federal funds rate between zero and 0.25 percent through at least mid-2013 to promote spending.

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