Wednesday’s dire auction of German bunds signals the ‘last domino’ to fall in the eurozone saga, we are now in the grip of financial panic. That’s the message from Eric Lonergan, manager M&G’s Macro Episode fund.
‘I think yesterday’s auction is dispelling the myth of Germany’s virtue,’ Lonergan told Citywire on Thursday.
‘Until now the general consensus was that if you were competitive and pursued austerity, then that would solve the problem. That has been the ECB’s view, and that of a segment of the political elite, for some time. However what we’re really now dealing with is financial panic.’
‘The market is now making a distinction between governments that can print money and those that can’t.’
‘Germany can’t and when you when you look closely at the numbers in Europe, Germany also has a worse primary balance than Italy as well as a higher government debt to GDP than Spain, so in many ways it has been lucky to have benefitted from capital flight up until this point.’
He adds that while Germany has profited from an emerging market capex spending boom, as a consequence, it has made its economy highly cyclical – an unattractive profile in the current environment.
‘Markets are aware of this and that is why the failure of the bond auction is very significant. It’s about financial panic, it’s not about virtue, it’s not about who’s right or wrong anymore.’
Such swift contagion from one country to the next as we have seen in recent weeks he says is a ‘classic feature’ of a financial panic. Drawing parallels between the situation in Germany and that of Hong Kong in the Asian crisis of 1997-98 he said:
‘The Asian crisis started in Thailand then moved on to Indonesia then Korea, Malaysia and finally to Hong Kong which was a bit like Germany as it was the last domino to fall before we had LTCM.’
However Lonergan does not think the worst case scenario will come to pass as he believes the gravity of this latest twist will force the hands of policymakers and central banks to act in a meaningful way.
‘The good news to come out of Germany as a domino falling is that it will bring about a co-ordinated global response to the crisis,’ said Lonergan.
‘I expect the response will be conventional but will not focus on targeting yields. We’ll see interest rates being cut and more quantitative easing and we’re likely see it from the combined might of the Fed, the Bank of Japan, the Bank of England and even the Bank of China.’
‘Co-ordinated quantitative easing is the best solution. I wouldn’t be surprised to see something over the weekend or in the next week or so and I suspect that’s why equity markets are doing quite well – markets have a sense that something is afoot so I therefore think it is entirely reasonable to expect an imminent policy response.’
In the Equity Global sector covered by Citywire's analysis Lonergan has returned 2.7% over one year to the end of October 2011, versus a loss of 3.5% from the average manager over the same period.