Bonds issued by the Eurozone's weaker nations have been relatively immune to the Greek crisis. That may create a false sense of calm.
The election of anti-austerity party Syriza has rekindled concerns that Greece could leave the Eurozone. The country's three-year bond yields are pricing in a nearly 30 per cent chance of default, even after its finance minister rowed back from demands for a haircut. Yet markets are being kinder to other indebted countries such as Portugal, Spain and Italy. Portugal's spread over 10-year German debt has risen 25 basis points since the Greek election, but remains below its 2014 average.
Policymakers may conclude that Europe is strong enough to withstand the contagion from a Greek exit, and that its crisis-fighting tools could contain the fallout. That reasoning is fragile.
True, all peripheral countries have tightened their fiscal deficits since the 2010 sovereign crisis. At the time Spain, for example, was expected to generate a cyclically adjusted deficit of 8.5 per cent, according to European Commission (EC) forecasts. The EC now forecasts a deficit of 2.4 per cent in 2015. But even though fiscal deficits have shrunk, debt in troubled countries has grown, while unemployment has risen across the zone. Markets would start to doubt other countries' ability to stay in the single currency.
The Eurozone's firefighting tools have improved in the last five years. The region has bailout funds and the beginning of a banking union. The European Central Bank has two bond-buying schemes at the ready. Unlike in 2010, these tools would probably help fight contagion.
There is even a chance that the trauma of a Greek exit will scare other populist movements, incite governments to step up reforms, and jolt northern Europe to invest more.
There are less benign outcomes. After suffering acute losses on their Greek exposure, Eurozone governments might be more reluctant to come to the rescue of countries suddenly placed in markets' cross hairs. Over the medium term, those economies may face permanently higher funding costs, as markets would realise that leaving the euro is possible. Political divisions, and support for radical solutions, would intensify.
Markets may be counting for now on politicians doing the right thing. There's always the risk that complacency might make a mistake more likely.
The election of anti-austerity party Syriza has rekindled concerns that Greece could leave the Eurozone. The country's three-year bond yields are pricing in a nearly 30 per cent chance of default, even after its finance minister rowed back from demands for a haircut. Yet markets are being kinder to other indebted countries such as Portugal, Spain and Italy. Portugal's spread over 10-year German debt has risen 25 basis points since the Greek election, but remains below its 2014 average.
Policymakers may conclude that Europe is strong enough to withstand the contagion from a Greek exit, and that its crisis-fighting tools could contain the fallout. That reasoning is fragile.
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The Eurozone's firefighting tools have improved in the last five years. The region has bailout funds and the beginning of a banking union. The European Central Bank has two bond-buying schemes at the ready. Unlike in 2010, these tools would probably help fight contagion.
There is even a chance that the trauma of a Greek exit will scare other populist movements, incite governments to step up reforms, and jolt northern Europe to invest more.
There are less benign outcomes. After suffering acute losses on their Greek exposure, Eurozone governments might be more reluctant to come to the rescue of countries suddenly placed in markets' cross hairs. Over the medium term, those economies may face permanently higher funding costs, as markets would realise that leaving the euro is possible. Political divisions, and support for radical solutions, would intensify.
Markets may be counting for now on politicians doing the right thing. There's always the risk that complacency might make a mistake more likely.