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Spanish and Italian 10-year bonds are back below 5 per cent; Italian government bonds have so far returned 12 per cent in 2012 – unheard of in developed country sovereign bond markets. Corporate bond markets have rallied hard. Eurozone equities have soared, with major markets up more than 20 per cent from their November lows; bank stocks have led the way, many up more than 50 per cent. Fund managers left behind in this rally are now sitting on the sort of underperformance that typically induces night sweats.
Without losing sight of what could still go wrong, it's worth asking what else could go right. Those still waiting for a big bazooka are certain to be disappointed. If the eurozone is to pull itself out of the crisis, it is going to continue to do so slowly, step by step, via deep structural reforms to restore competitiveness and boost long-term growth potential and fiscal austerity to pay down debt. This should, over time, enable Member States to rebuild trust, creating conditions for further political union.
That is a hard road, but it is not impossible. In fact, there are signs some economies are already adapting. Current account deficits in peripheral countries—a key measure of the imbalances that lie at the heart of the crisis—have more than halved in the past three years. Since the second quarter of 2008, the aggregate deficit for Spain, Portugal, Ireland, Greece and Italy has fallen from 10.9 per cent of GDP to 4.3 per cent, notes Deutsche Bank. True, in Greece and Ireland, this adjustment has largely come from a collapse in imports as austerity has crushed domestic demand. But Spanish exports have grown 12.5 per cent in 2011, a bigger increase in share of world trade than Germany. Portugal has also shown strong export growth.
What's interesting about Spain and Portugal's export success is that it was driven by companies seeking out new markets. That's a reminder there's more to restoring the periphery's competitiveness than cutting labor costs relative to Germany; other important factors include boosting productivity, increasing innovation and improving marketing, and customer service. It's also a reminder that it's not governments that will pull the eurozone out of the crisis. Governments need to create conditions to help businesses flourish through supply side reforms and by ensuring banks are about to provide finance. The European Union can also help by deepening the single market in areas such as energy and services and providing structural funds to improve infrastructure. But it is the creativity and dynamism of businesses and entrepreneurs that will create the growth.
Many of those quickest to write off the eurozone's chances profess to believe in market economics yet have a surprising lack of confidence in capitalism. Of course, it is a tall order for peripheral countries to reduce current account deficits—and reliance on foreign funding—via increased exports and domestic import substitution alone. For Portugal in particular, where exports are only equivalent to 30 per cent of GDP, improving trade balances are unlikely to offset fiscal austerity.
But given a fair wind from the rest of the world economy and a continued commitment to structural reforms, it's possible capitalism will do what it is supposed to do. Indeed, there are encouraging signs of a breakdown in correlations in markets, both between asset classes and within stock market sectors. That points to investors becoming more discriminating, focusing once again on the micro and not just the macro. If strong companies start to outperform weak companies, that will create powerful incentives: Deals should start to pick up, investment will start to flow, jobs will start to be created—and the bears will get squeezed even further.
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