This past weekend, German and French government officials took a hard line on aid to Greece, sending 10-year Greek bond yields to 12-year highs above 9%. According to the Wall Street Journal, the spread in yields between 10-year Greek debt and German debt —considered the euro-zone’s most reliable sovereign debtor — increased to a record 6.11 percent. Just Friday, the spread was 5.63 percent, even after Greece asked to activate its aid package.
So clearly, there is a deterioration in sentiment toward Greece. Brown Brothers Harriman’s Win Thin writes:
Of course, no developed country besides Greece is seeing such high yields, and so we need to go to the EM space for any comparisons, and it’s not a pretty sight. Greek 5-year yields are 10.6%, up 113 bp today. That’s well above 5-year dollar bonds for the weakest EM credits, such as the 10.5% yield on Ecuador due 2015, 7.6% for Pakistan due 2016, and 7.1% on Ukraine due 2016. The only two countries that have higher 5-year yields than Greece are the 11.5% yield on Venezuela due 2016 and the 11.7% yield on Argentina due 2015. Greek 2-year yields are currently at 12.99%, up 285 bp today. In the shorter end for weak EM credits, there are only Argentina 2012 (8.8% yield), Ukraine 2012 (5.8% yield), and Venezuela 2013 (11% yield) to compare with, and Greece is currently higher than them all. We are in the process of dusting off our fixed income tools (last used when Argentina defaulted in 2002) with regards to what the yields are telling us. But clearly, there is significant default/restructuring/haircut risk being priced in right now for Greece.
Moreover, Greece is having a deleterious effect on other weaker sovereign debtors in the euro-zone. Portugal’s 2-year yields are up 74 bp today (152 bp over the past week). Wolfgang Munchau has said:
The problem in Portugal is not the state sector. Portugal’s gross public sector debt is projected by the EU to be about 85 per cent of gross domestic product by the end of this year. This is high, but not exceptionally so. On my calculations, using data from the World Bank, Portugal’s external debt-to-GDP ratio, including public and private sectors, is a staggering 233 per cent – the government at 74 per cent and the private sector 159 per cent. The net international investment position is about minus 100 per cent of GDP – the amount by which Portugal’s financial assets abroad are outweighed by assets owned by foreigners in Portugal. The current account deficit is projected to remain at just under 10 per cent of GDP. This is an acute private sector crisis.
Ireland has seen 2-year yields up 66 bp today (135 bp over the past week) as it has the euro-zone’s largest budget deficit, due in particular to non-performing loans which the government has been forced to ring fence in a so-called bad bank.
If the Europeans don’t get this well in hand, we have the makings of another systemic credit crunch.
At issue are statements by German and French politicians at the weekend which call into question whether Greece can survive this crisis without defaulting or receiving a voluntary restructuring of its debt. In Germany, a number of parties outright reject the aid package as presently configured.
German Chancellor Angela Merkel and Finance Minister Wolfgang Schäuble have insisted that the Greeks introduce greater austerity measures. Even so, Merkel faces a potential revolt in her own governing coalition if she tries to move ahead with the terms already sketched out. The aid to Greece is also now being challenged in German court as unconstitutional. Moreover, another establishment figure, German Bundesbank head Axel Weber, told the Frankfurter Allgemeine newspaper that he believes the IMF is acting outside its core responsibilities.
It is problematic if the IMF is active outside the financing of current account deficits in foreign currencies. This applies generally and not just in the case of Greece. We need to talk about refocusing the IMF on its core mandate.
France’s Finance Minister Christine Lagarde described the aid package for Athens as a "cocktail of indulgence and great strictness." She too is calling for greater austerity measures. "We want to stabilise. But that doesn’t prevent us from being firm, and we will need to watch the results very carefully."
Meanwhile, a week of strikes is set to begin in Greece as the proposed austerity measures are being met with stiff resistance by citizens. This can only further decrease tourism to Greece, which is a major source of revenue for the economy.
No western European nation has defaulted on its debt obligations since World War II. If Greece does default, it would be a catastrophe that spreads far beyond Greece. It has already increased borrowing costs in Portugal and Ireland in particular. But the costs would spread to Greek banks and to the German, French or Swiss banks which hold Greek debt. Think Creditanstalt redux.
Are we witnessing a collapse of the euro-zone? At the very minimum, we are witnessing a sovereign debt crisis the likes of which we haven’t seen since the Great Depression.
- Les marchés font monter la pression sur la Grèce – Le Monde
- Greece is Europe’s very own subprime crisis – Wolfgang Munchau, FT
- Maastricht madhouse fuels EMU-wide contagion from Greece – Ambrose Evans-Pritchard, Telegraph
- Grecia inicia una semana de huelgas ante la grave crisis financiera – El Periódico de Catalunya
- Greek bailout not limited to €45bn, ministers warn – Guardian
- „Der IWF legt seine Regeln sehr weit aus“ – FAZ