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The U.S. continues to avoid Eurozone contagion

The Greeks yesterday voted to keep trying to fix their problem, but there remains much to be done and markets were understandably unimpressed. Still, I note some encouraging signs. As the charts above show, there has been virtually no contagion effect of the Eurozone crisis on the U.S. Conditions remain tenuous in the Eurozone, with swap spreads still uncomfortably high (though not extremely so), but systemic risk in the U.S. is remarkably normal. The Eurozone crisis has been brewing for over two years, and although U.S. markets have had their confidence shaken a few times, in the end the U.S. economy has continued along its path of slow improvement while the Eurozone economies have for the most part slipped into recession; the S&P 500 has climbed irregularly higher, while the Euro Stoxx index has slipped irregularly downward.

This next chart tells the same story but with a different twist. It compares the ratio of the Vix index (a measure of fear) to the 10-yr Treasury yield (a measure of the market's confidence in the U.S. growth outlook) with the yield on Spanish 2-yr bonds (a measure of the near-term likelihood of a Spanish default). This shows how rising tensions in the Eurozone have tended to coincide with bouts of increased fear and despair in the U.S. Interestingly, over the past year the Vix/10-yr ratio has tended to lead the Spanish 2-yr yield, and so the recent decline in the Vix/10-yr ratio could be telling us that the worst of the Eurozone crisis has passed and that Spanish yields could once again decline in the next several months. In any event, I note that despite today's record-setting high in Spanish 10-yr yields (reflecting acute investor distress over the prospect of an eventual Spanish default), the Vix/10-yr ratio today is only about half as high as it was late last September, when the Eurozone was on the verge of its second panic attack. Message: the Eurozone is really taking a hit, but the U.S. remains largely insulated.

With markets here still dominated by fear (e.g., PE ratios significantly below average, the 10-yr yield close to record lows, and $6.3 trillion sitting in banks savings accounts earning almost nothing), the longer the U.S. economy avoids a calamity, the more likely it is that risk assets rise. That is a plausible explanation for why U.S. equities and commodity prices have moved up this month even as Eurozone yields and fears have increased. Conditions in the U.S. are far from terrific, but in comparison to the Eurozone they are pretty good.

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