Where next after May's month of mayhem? Rob Davies column

It seems that the European authorities are powerless to restore confidence to the financial markets, and the prospect of a double-dip recession is looming closer.

Rob Davies, editor, Credit magazine

Earlier in the year, whenever I asked investors and bankers if they thought a double-dip recession was a possibility as the Greece crisis emerged, it was surprising how many dismissed the idea.

Perhaps after last year’s dramatic reversal of fortune in the credit markets, and the way in which corporate earnings had rebounded, they had good grounds to be optimistic.

However, if the 2007–2009 crisis (and plenty of crises throughout history) proved anything, it was that a seemingly isolated and containable problem can very quickly shake confidence and cause contagion to spread into other markets. Looking at how the markets reacted to events in May, it now seems reasonable to ask whether things are about to take another serious turn for the worse.

Throughout this year a trend has emerged: after every announcement of external support for Greece and other struggling southern European sovereigns, the markets initially react positively before quickly (usually inside a couple of days) heading the other way again.

And so it was in May: neither the EUR110 billion EU-IMF financial support package for Greece announced on May 2, nor the EUR750 billion pool of funds made available on May 11 to underpin sovereign debt throughout the Eurozone, was enough to convince investors that ailing economies will be able to get a grip on their debts without provoking major social unrest.

If Germany thought the imposition of a short-selling ban on naked credit default swaps and certain financial stocks would calm the waters, it was grossly mistaken. In fact, the ban made the situation considerably worse, while at the same time exposing the fallacy that G-20 governments are committed to co-ordinating regulatory reforms of the financial sector.

May gave the first real indications that sovereign woes are spreading to other markets. Equity markets tanked, liquidity evaporated, corporate and financial credit spreads widened dramatically, and primary issuance almost ground to a halt in Europe. According to Dealogic, European issuance of $27.1 billion in May, of which only $6.5 billion was by corporates, is the lowest monthly total since August 1997.

It is difficult to see anything on the imminent horizon that will restore confidence and cause the current risk aversion among investors to abate. In such an environment, perhaps the possibility of a double dip is no longer pure fantasy after all.

Rob Davies