20180712-NATIXIS-Are_euro-zone_governments_subject_to_market_discipline__5页_701kb

Flash Economics Summary: Market Discipline in the Euro Zone

Core Content

This document explores the question of whether fiscal policy in the euro zone is subject to market discipline. It evaluates the role of financial markets in enforcing fiscal responsibility through interest rates and examines the factors influencing sovereign risk premia in peripheral euro zone countries, such as Spain, Italy, and Portugal.

Main Views

1. Debate on Fiscal Discipline Mechanisms

• The euro zone faces a critical debate on how to ensure fiscal solvency:

  • Strict fiscal rules with sanctions for non-compliance.
  • Market discipline, where interest rates react to the risk of default due to excessive fiscal deficits.

• Market discipline is only effective if investors believe that:

  • Excessive fiscal deficits will lead to default.
  • These countries will not be bailed out by the ECB, other countries, or international institutions like the ESM or IMF.

2. Sovereign Risk Premia Analysis

• Risk premia on government bonds of Spain, Italy, and Portugal have increased in two key periods:

  • 2010–2014
  • Since May 2018

• These increases may reflect:

  • Debt default risk (market discipline in effect)
  • Currency risk (euro zone breakup and depreciation of peripheral countries' currencies)

3. Differentiating Default Risk from Currency Risk

• To determine the nature of the risk premium, the document compares:

  • Fiscal deficit (Chart 2)
  • Debt stabilisation gap (Charts 3A, B, and C)
  • Euro exchange rate (Chart 4A)
  • Net open position in the euro (Chart 4B)

• Key observations:

  • From 2010 to 2014, fiscal solvency was not ensured, and the euro was in short positions, yet the currency did not depreciate significantly.
  • In 2018, the euro's net open position fell, and the currency depreciated slightly, but this did not correlate with a rise in risk premia, suggesting default risk was the primary concern.

4. Conclusion on Market Discipline

• The risk premia on sovereign bonds of Spain, Italy, and Portugal primarily reflect debt default risk, not the risk of the euro zone breaking up.
• Therefore, fiscal policy in the euro zone is subject to market discipline, as investors react to the likelihood of default rather than broader currency risks.

Key Information

• Fiscal discipline can be achieved either through rules and sanctions or through market reactions.
• Sovereign risk premia are influenced by default risk, not necessarily by currency depreciation.
• The 2010–2014 and 2018 periods show different dynamics in how markets perceive risk.
• The document is not a personalized investment recommendation and is intended for professional and qualified investors only.

Disclaimer Highlights

• The document is confidential and intended for specific recipients.
• It is not a financial analysis and not subject to legal requirements promoting investment research independence.
• No liability is accepted for the distribution, use, or interpretation of the document.
• Natixis is supervised and regulated in various jurisdictions, including the ECB, ACPR, BaFin, Bank of Spain, CNMV, Bank of Italy, CONSOB, and others.
• The views expressed are the personal opinions of the authors and may differ.
• The document is not an offer or solicitation for any transaction.

Regulatory Notes

• In Canada, the document is for "permitted clients" only.
• In Australia, it is for "wholesale" clients through a subsidiary, NAPL.
• In Hong Kong, it is for professional investors only.
• In the United States, the document is for major institutional investors and not for general public distribution.

Final Note

The document concludes that market discipline plays a significant role in the euro zone, as sovereign risk premia reflect debt default risk rather than currency risk, indicating that investors are pricing in the risk of fiscal irresponsibility.