macroblog

About

---

Disclaimer

Comment Standards

Subscribe by E-mail

Subscribe by RSS

All Atlanta Fed RSS

Other Fed Web Sites

« Increasing hours worked versus increasing hiring | Main | How close to deflation are we? Perhaps just a little closer than you thought »

June 30, 2010

---

Keeping an eye on Europe

In June, a third of the economists in the Blue Chip panel of economic forecasters indicated that they had lowered their growth forecast over the next 18 months as a consequence of Europe's debt crisis. When pushed a little further, 31 percent said that weaker exports would be the channel through which this problem would hinder growth, while 69 percent thought that "tighter financial conditions" would be the channel through which debt problems in Europe could hit U.S. shores.

Tighter financial conditions also were mentioned by the Federal Open Market Committee in its last statement, where the committee noted, "Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad."

In his speech today, Atlanta Fed President Dennis Lockhart identified the European sovereign debt crisis as one of the sources of uncertainty for the U.S. economy that he believes "have clouded the outlook." President Lockhart explicitly expressed his concern that Europe's "continuing and possibly escalating financial market pressures will be transmitted through interconnected banking and capital markets to our economy."

Negative effects from the European sovereign debt crisis can be transmitted to the U.S. economy through a number of financial channels, including higher risk premiums on private securities, a considerable rise in uncertainty, and sharply increased risk aversion. Another important channel is the direct exposure of the U.S. banking sector—both through holdings of troubled European assets and counterparty exposure to European banks, which not only have a substantial exposure to the debt-laden European countries but have also been facing higher funding costs. The LIBOR-OIS spread has widened notably (see the chart below), liquidity is now concentrated in tenors of one week and shorter, and the market has become notably tiered.

(enlarge)

Banks in the most affected countries (Greece, Portugal, Ireland, Spain, and Italy) and other European banks perceived as having a sizeable exposure to those countries have to pay higher rates and borrow at shorter tenors. Although for now U.S. banks can raise funds more cheaply than many European financial institutions, some analysts believe that there's a risk that the short-term offshore dollar market may become increasingly strained, leading to funding shortages and, conceivably, forced asset sales.

Bank for International Settlements data through the end of December of last year show that the U.S. banking system's risk exposure to the most vulnerable EU countries appears to be manageable. U.S. banks' on-balance sheet financial claims vis-á-vis those countries, adjusted for guarantees and collateral, look substantial in absolute terms but are rather small relative to the size of U.S. banks' total financial assets (see the chart below). The exposure to Spain is the biggest, closely followed by Ireland and Italy. Overall, the five countries account for less than 2 percent of U.S. banks' assets.

(enlarge)

U.S. exposure to developed Europe as a whole, however, is much higher at $1.2 trillion, so U.S. financial institutions may feel some pain if the European economy slows down markedly. How likely is a marked slowdown? It's difficult to determine, of course, but when asked about the largest risks facing the U.S. economy over the next year, the Blue Chip forecasters put "spillover effects of Europe's debt crisis" at the top of their list.

By Galina Alexeenko, economic policy analyst at the Atlanta Fed

June 30, 2010 in Banking , Europe , Forecasts | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef0134851e6398970c

Listed below are links to blogs that reference Keeping an eye on Europe :

Comments

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

Please submit appropriate comments. Inappropriate comments include content that is
      abusive, harassing, or threatening;
      obscene, vulgar, or profane;
      an attack of a personal nature; or
      overtly political.

In addition, no off-topic remarks or spam is permitted.

You are currently signed in as (nobody). Sign out

Name:

Email Address:(Not displayed with comment.)

URL:

Remember personal info?

Comments: