Greek Troubles Continue to Weigh on the Euro

The pressures on Greece continue to increase and this fact is reflected in the credit default swaps and the country's interest rate spread over Germany. Indeed, that is a key development in the euro zone over the past month. Greece yields have risen above Ireland, which had been the highest yield in EMU this year. Ten year Greek yields are just below 5%, while Ireland is near 4.75%.

Greece fundamentals are poor. It was lagged going into recession and may lag on the exit. That lag may mean that the ECB may unwind some liquidity facilities before Greece is ready.

As we have noted previously, the new Greek government revealed a much larger deficit that the outgoing government 'fessed up to. The budget deficit this year is near 12% of GDP. The current account deficit was around 14.5% of last year and is fallen this year. The monthly deficit is around 2 billion euros this year, which is about a third smaller than the same period in 2008.

The EU estimates that Greece's public debt to GDP stood at almost 100% last year and will rise to 135% by the end of 2011 without dramatic action.

Some of the efforts of the new government, which had campaigned on a platform to increase spending, to rein in spending, like freezing state worker pay at 2000 euros a month, is meeting stiff resistance.

Greece has moved to shorter maturities to reduce its debt servicing costs, but this will "kick the can" down the street but only until Q2 next year, when Greece will have 18 billion euros coming due.

The new talk on Tuesday suggests that senior Greek officials are meeting with several large Chinese lenders and a possibly a couple of large US banks to either buy Greek bonds in the secondary market or in a future placement.

Why should investors with no Greek exposure be interested in this story?

First, as tensions on the periphery remain high, with Greece just the most acute example, it could influence the timing and magnitude of the ECB's withdrawal of liquidity. When the ECB first offered one-year funding at a fixed rate of 1%, we suggested that in that act of monetary policy lay a fiscal support program on ideas that some of the receivers of the funds would buy high yielding European bonds and interest rate differentials over Germany did narrow, lending credence to our argument. One of the implications of the pressure in the region is that it may favor the ECB replacing 12-month refi operations with a six month operation(s).

Second, the pressure on Greece may spill over to other periphery members. This is not to suggest that Greece or another country will drop out of the euro zone, like "bets" suggested the odds of a country dropping out of the euro zone by the end of 2010 was nearly 1 in 3. Those odds have fallen considerably.

The point is that the euro zone remains a great experiment of monetary union without political union. This coupled with the fact that member countries do not control the euro printing press, like the US controls the dollar press and UK the sterling press, makes it harder to conceive of the euro eclipsing the dollar.

Thirdly, the pressures on Greece may illustrate that the opportunity for strains that were felt sharply during the crisis will not necessarily diminish during the recovery. Inside the euro zone, few countries can compete with German and its ability to resist upward pressure on unit labor costs. Outside of the euro zone, many key trading partners, like the UK, have experienced currency depreciations that adversely impact some euro zone members.

Disclosure: No positions

Comments

[AJ Clausen]

To bet on falling government bond prices of various EU members is certainly a way to trade. But to believe that the EURO is doomed or that a member country will leave the EU or EURO zone is just - lets say - simpleminded.
Look at California nowadays, where no one believes, that the US are breaking up or a state is taking another currency. The highlight of academic ignorance and incompetence were Krugman's calls for a bankrupt Austria.
Greece on the other side always had a history of dressed up fiscal numbers and it was always doubtful if the idea was so clever to accept this country economically into the EURO zone (politically Greece is the historical heart of European democracy). The same goes for Italy, though her economy is certainly in another class.
But still the same, the EURO will not break up and the EU will persist.

2009 Nov 25 02:03 AM

[Fibozachi]

Am an avid admirer of your work Mr. Chandler ... always well written, always thorough. Thank you for both sharing it and being so consistently actionable.

We're eagerly looking forward to hearing the squeals of the PIGS once again ... especially once the DX/ $USD reclaims 81/ 84 and the next round of CB swap lines are effectively introduced ...

... would NOT be short DX and would only be looking/ lurking/ waiting patiently for an ACTUAL trading signal, or four, that says bottom.

75.88 and 76.82 (.89 to be safe) must be closed above to shift the profile from bearish-neutral to neutral bullish ... 75.88 MUST see two consecutive closes above it on a 135 minute (1/3 the cash session); we prefer using natural time and the 144 (FIBO) minute since the world trades DX/ $DXY.

2 consecutive closes above 76.89 and get ready for the powderkeg that is Eastern Europe to start lighting up fireworks that reach China's copper stockpiles ... as the CDS of the PIGS (portugal, italy, greece and spain) skyrockets like the DSI et al. for Gold.

And for you goldbugs out there ... pay attention to Aussie & Swissie for early signals of a major, Full Cycle top and impending parabolic pop ... EURJPY is THE risk metric to watch for equities (domestic & global) themselves since they don't care about the TED Spread or IG ... silly bond markets, equities are for kids.

2009 Nov 25 11:59 PM

[Pkpetro]

Η ΕΛΛΑΔΑ ΠΟΤΕ ΔΕΝ ΠΕΘΑΙΝΕΙ...

2009 Nov 26 07:03 AM