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By Jeremy Glaser and Dave Sekera, CFA | 11-14-2012 11:00 AM

Europe Still Papering Over Problems

The European Central Bank has helped soothe short-term sovereign debt worries in Europe, but long-term competiveness must be improved for the crisis to fully fade away, says Morningstar's Dave Sekera.

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. We've had a bit of a quiet period in the European sovereign debt crisis, but is this just the lull before the storm? I'm here with Dave Sekera, Morningstar's corporate bond strategist, to take a look at the crisis.

Dave, thanks for talking with me today.

Dave Sekera: Happy to be here, Jeremy.

Glaser: So, let's talk a little bit about why the headlines seem to have moderated a lot over the last couple months. Is it just because we've been focused so much on the presidential election, or on the so-called U.S. fiscal cliff, or has there been a real softening in the crisis in Europe?

Sekera: Well, I think it's twofold. I think you did get it right that the news media here has definitely been concentrating its time on the elections, and now that the elections are over, looking at the fiscal cliff. And actually in addition to the fiscal cliff, we also have to realize we're going to be coming up on the debt ceiling again pretty soon, and I think that's going to have to get wrapped up into the fiscal cliff negotiations which you haven't seen too much news, so that's something that's going to be on the horizon coming up as well.

Secondly, Mario Draghi, the president of the European Central Bank, had come out a number of months ago, and he had talked about doing whatever the ECB had to do in order to be able to preserve and save the euro, and essentially they created what they called OMT, the Outright Monetary Transaction program. Essentially what that is, is that any country within the EU that needs a bailout essentially, that requests one, if that gets approved by the troika, then he would be willing to go out and buy the sovereign credit or the sovereign bonds of that individual nation in order to support the bond prices and keep yields relatively low.

So, with that out there, we saw Spanish bonds, the yields drop pretty dramatically. I think they are still below 6% right now on the 10-year bonds, and the two-year bonds are well under control as well. So, they've really kind of papered over the problems that we'd seen for the past couple of months. There has definitely been a lot more rumblings as far as what's going on with Greece. As you know, last week Greece did pass some more austerity measures, some more structural reforms, and they needed to get that done as a precondition for the next tranche of bailout financing from the troika; the troika being the European Union, the International Monetary Fund, and the ECB. So now they're just negotiating among themselves.

Do we still keep Greece on track that they have to get their debt/GDP levels down to 120% by 2020? I think some of the EU members are trying to loosen that up that that they don't have to hit that target until 2022. However, the IMF is still out there pushing for the 2020 date. We know that Greece has a couple of different bond issues that mature before the end of this month. They need to get the cash in the door to be able pay for those. However, even if they don't get the cash in the door, there still enough mechanisms out there that the ECB can essentially finance that until Greece gets the next tranche in.

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