As of early February, conditions are by no means as serious as last summer, although some upward pressure has now crept into peripheral yields thanks to developments in Spain and Italy. Just when everyone thought that the crisis had been contained, we have been reminded that the political situation in many European states remains unstable.
In Spain, Prime Minister Rajoy faces serious accusations of receiving illegal cash payments, while Silvio Berlusconi appears to be staging a late comeback in the Italian election campaign, making a hung parliament outcome more likely.
If uncertainty continues to grow, then investors will continue to pay up for protection against a tail-risk outcome, and avoid assets such as equities, which would suffer if the tail risk – in this case a break-up of the euro – materialised.
Outside developments in the euro crisis, the latest global PMI data suggest a gradual pick-up in economic activity, especially in the US and Asia. Even in Europe, there are signs that although the economy remains in recession, activity is beginning to stabilise, thanks to a general improvement in global trade and an easing in financial conditions since last summer.
Assuming recent developments in Spain and Italy do not grow into something much more serious, equities should continue to benefit from a gradual improvement in economic news.