2010-05-04 European Sovereign Debt Crisis in Perspective F
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This is for investment professionals only and should not be relied upon by private investors FIXED INCOME MAY 2010 Euro-zone sovereign risk: Will the Greek debt crisis be contagious or contained? Fear and contagion have broken out in European sovereign bond markets. The well- documented government debt problems in Greece - which are by common consent much worse than anywhere else in the Euro-zone - prompted the Greek government to ask foremergency funding from the IMF. Despite fears over Germany’s lack of political appetite, Euro-zone finance ministers green- lighted a $110 billion rescue package, which significantly reduces the danger of a debt restructuring in the short-term. The larger than expected package, which includes painful austerity measures and quarterly IMF spot-checks, seems to have credibility. However, it remains to be seen whether this will restore confidence in all Euro-zone bond markets and the single European cur rency. Could the contagion spread to other peripheral European economies? And, could it derail the global economic and stock market recovery? GREECE IS A BASKET CASE We have known for some time that the Greek economy is in a very bad state. However, that weakness now threatens to cast a dark cloud over the entire Euro-zone. Despite the fact that most market observers anticipated Greece would need IMF help, the confirmation of the need for a bail- out nevertheless inspired panic in sovereign bond markets. Bond investors pushed up yields in Portugal, Spain and Ireland, concerned by the possibility that these economies might be next in the IMF queue. Standard & Poor’s reacted by downgrading Greece by three notches to BB+ or junk status, while reducing Portugal’s sovereign rating from A+ to A- and Spain’s by one notch to AA. If Greece is in such a bad way, should we be worried about other Euro-zone economies with, what are on the face of it, a similar set of fiscal pressures? On balance, probably not. Greece is a basket case. It is the ‘weakest link’ in the Euro-zone by a significant margin. And, while other economies have their problems, there are reasons to believe they are surmountable. On the other hand, there are reasons to doubt Greece’s problems can be overcome and austerity measures can be successfully impl emented. This is because Greece’s dire financial situation is exacerbated by some specific structural weaknesses that are specific to its economy, Greek working practices, retirement laws, political stability and the size of the state. While the $110 billion emergency funding stabilises the short-term situation, these structural issues are likely to challenge the austerity plan and cloud the medium to long-term outlook. AT A GLANCE: TIMELINE 23 April: Greece formally applies forfinancial assistan ce from the IMF. Instead of calming investors, it triggers panic in Euro-zone sovereign bond markets. 28 April: Fears over Germany’s willingness to agree an EU bailout sees the yield on Greek 2-year bonds soar past the 25% mark (now back to around 10%). 28-29 April: Standard & Poor’s cuts the sovereign ratings of Greece, Portugal and Spain to ‘junk’, ‘A-‘ and ‘AA’ respectively. 02 May: Euro-zone finance ministers approve a $110 billion finance package. 03 May: Euro slides to a 12-month low against the US dollar as short positions against it hit a record high.KEY POINTSThere has been limited new factual news- flow behind recent events. Most market observers anticipated Greece would require emergency funding. Confirmation of the need for a bail-out raised the fear level and attention quickly focused on other ‘suspect’ economies such as Portugal, Spain and Ireland. Global economic conditions remain robust and the corporate sector has been reporting healthy earnings. The crisis should largely be contained to Greece and the global economic and stock market recovery left intact. The slide in the euro is actually a net positive for European equities. This combined with attractive valuations in many areas, means there are attractive opportunities available. THE SPIKE IN BOND YIELDS – GREECE IS THE ‘WEAKEST LINK’ 0 2 4 6 8 10 12 May- 07 Sep-07 Jan- 08 May- 08 Sep-08 Jan-09 May- 09 Sep-09 Jan-10 May- 10 R e d e m p t i o n Y i e l d Portugal Greece Germany Ireland Spain UK Source: DataStream, as at 30.4.10. Redemption yields on Benchmark 10-Year Government Bonds for countries shown.
2010-05-04 European Sovereign Debt Crisis in Perspective F
