Europe, U.S. debt talks put pressure on stocks

Continuing worries over the European government debt crisis and political deadlock in Washington as a Nov. 23 deadline for deficit reduction draws near could mean more selling pressure on stock markets this week.

Continuing worries over the European government debt crisis and political deadlock in Washington as a Nov. 23 deadline for deficit reduction draws near could mean more selling pressure on stock markets this week.

Meanwhile, American markets will be operating on a very short work week because of the U.S. Thanksgiving holiday on Thursday, which could leave many investors on the sidelines.

“People are going to shift into U.S. mode,” said Andrew Pyle, investment adviser with ScotiaMcLeod in Peterborough, Ont..

Stock markets fell heavily last week as Italy and Spain were forced to pay high premiums to entice traders to buy their bonds.

Yields moved past seven per cent during the week, a level economists view as unsustainable, before drifting slightly below that threshold at the end of the week.

There is growing impatience with European leaders to come up with a credible plan for dealing with the eurozone’s government debt crisis and analysts say bond markets are sending an unmistakable message.

“In the absence of timely and significant, meaningful structural reform in euroland, the bond market is losing confidence,” said Paul Taylor, chief investment officer at BMO Harris Private Banking.

“And as they lose confidence, the solvency issues that exist become imminent dangers because with yields going higher, the debt servicing costs go through the roof and this day of reckoning is fast approaching.”

The Toronto market tumbled 384 points or 3.13 per cent last week as investors become more wary of making bets because of the uncertainty surrounding the debt crisis and frustration over an apparent lack of recognition by eurozone leaders that time may be running out and available options dwindling.

“There may have been a menu of options years ago but there’s no more menu of options,” said Pyle.

Many analysts say that bond markets would be reassured if the European Central Bank would just come out and declare itself to be the lender of last resort.

However, this idea is strongly resisted by the ECB itself and the German government.

The region could also decide to change the makeup of the eurozone but such a move would open up a big can of worms.

Pyle said this would involve basically getting rid of Greece, Spain, Portugal, imposing huge haircuts for sovereign debt bondholders in the neighbourhood of 80 per cent and giving those countries back their individual currencies.

However, the result would “be a massive kind of implosion in the capital markets if they do that.”

“We’re talking about (is) substantial amounts of capital that would be dislodged around the world, with serious ramifications around the world.”

The European debt issue has big ramifications for the Canadian market because there are increasing worries that the region will get stuck in a serious recession next year, which could derail the global recovery and crush demand for commodities. Higher commodity prices are a prime source of support for the resource-heavy TSX.

Meanwhile, hopes are slim that a 12-member panel of Republicans and Democrats can beat a U.S. Thanksgiving deadline to produce at least US$1.2 trillion in deficit cuts over the coming decade.

Familiar battles over tax increases and cuts to benefit programs continue to hang up the panel, with neither side optimistic about a deal.

Memories are still fresh of the fierce political backbiting that surrounded negotiations for raising the U.S. debt ceiling in August.

That resulted in ratings agency Standard & Poor’s downgrading the U.S. sovereign debt rating from the country’s top-shelf AAA status to AA+, the next level down.

S&P cited “difficulties in bridging the gulf between political parties” as a major reason for the downgrade.

The worry is that other agencies such as Moody’s and Fitch could follow suit this time around if lawmakers can’t agree on ways to rein in huge U.S. government debt.

Pyle notes that ratings agencies are still smarting from handing out undeserved AAA ratings to mortgage securities in 2006 and 2007 and now they’re being much more careful.

“And this is why I don’t think they will waste time on Nov. 23. They will whack the rating (if an agreement isn’t reached),” Pyle said.

“So much for a Christmas rally then.”