NEW YORK: Markets applauded Europe's steps to move toward a closer union — but it's not clear European voters are going to play along.
That worries investors, particularly when Europe appears more deeply divided than at any time since the common currency was introduced in 1999.
Europe's decision to bend its aid rules to help Italy and Spain and move toward creating a common bank supervisor pushed it a step closer to a tighter union.
Yet even if European leaders can put aside past differences and start building a United States of Europe, voters may resist what they see as a loss of sovereignty. That may rebound on markets if a lot of effort goes wasted.
"A lot of people in Europe don't want to be part of one country," said Simon Pryke, chief investment officer at Newton Investment Management in London, which oversees about $80 billion in assets. "There's a disconnect between politicians and the electorate. They are pulling in opposite directions."
Sweeping spending cuts and tax increases to reduce large budget deficits have provoked a backlash from Europeans across the 17-country currency union, particularly in countries with high jobless rates and low or negative growth.
Sizable minorities in recent French and Greek elections plumped for far-right or far-left parties rather than mainstream ones committed to European integration.
Germany, meanwhile, has opposed easing austerity measures and pushed back against calls for creating a common bond market.
"Nein! No! Non!" shouted a recent headline in a German newspaper urging leaders to resist efforts to make Germany underwrite other euro zone countries' debts.
Gregory Whiteley, who helps manage $35 billion at DoubleLine Capital in Los Angeles, said Friday's deal to let rescue funds be injected directly into banks rather than lent to already indebted governments was a significant step, particularly since it marked a softening of Germany's previous opposition.
But he said setting up a euro zone bank regulator to oversee such aid, something leaders said they would consider doing by the end of the year, could still prove a hard sell.
"We are still a long way from solving this because the resistance of voters on both sides — in Germany, to making concessions and in Southern Europe to facing up to the severity of the problem — is a big obstacle to getting a long-term, workable solution," he said.
Indeed, Der Spiegel characterized Friday's agreement as a defeat for Germany, which it said "caved in to demands for less stringent bail-outs and direct aid to banks."
As BNY Mellon strategist Simon Derrick put it: "It's clear the agreement was forced out of Germany under extreme duress. As a result, Germany looks politically isolated and, presumably, extremely annoyed. That would seem a dangerous combination."
This is partly why Whiteley says he doubts the rally in risky assets will persist. He warned against betting against a future rally in the dollar and safe-haven US Treasuries.
Mohamed El-Erian, CEO at Pimco, which runs the world's largest bond, echoed those sentiments in an interview with CNBC-TV.
"Our assessment is this is not yet the breakthrough. More is yet required," he said. "Therefore, there's the risk that once again this rally may run out of steam."
POLITICAL DISPERSION
The strains in public opinion and political consensus in Europe is not uncommon at a time when people are worried about their economic futures, said Peter Atwater, president of Financial Insyghts, an investment advisory based in Mendenhall, Pennsylvania.
It can be seen across the Atlantic as well. Atwater points to falling consumer confidence, intractable political gridlock and the rise of protest movements such as the Tea Party and Occupy Wall Street, all of which can complicate policymaking.
"I am bothered by the level of market confidence many investors have in European policymakers," he said. "There's a greater sense that because the consequences (of failure) are so dire, they must act. At the same time, you have mounting political dispersion, so the ability of governments to act decisively, rapidly and cohesively deteriorates."
Berkeley economics professor Barry Eichengreen said such political fragmentation is always a risk when economic conditions worsen. But he noted that Greece and France still managed to form mainstream governments after recent elections.
"There has been some movement toward the extremist parties on the left and right, but it could be worse," he said.
Even so, uncertainty about how the European debt crisis will end has kept investors wary of over-exposure to the euro or other euro zone assets, something Newton's Pryke said will likely persist for some time.
"There will be great buying opportunities in European equities sometime in the future," he said. "But not now."
