Thermopylae or Crete?

 |  Includes: FXE, IGOV
by: Cam Hui, CFA

Is the Greek rescue package another metaphorical Battle of Thermopylae? Recall that a small Greek rearguard, which was hopelessly outnumbered, held off the Persian army for a few days. They lost the battle but won the war. Or is this just the opening shot in the Battle of Crete in 1941, where German paratroopers annihilated the Allied defenders in an air assault on Crete? To quote Wikipedia's account:

After one day of fighting, the Germans had suffered very heavy casualties and none of their objectives had been achieved. The next day, through miscommunication and the failure of Allied commanders to grasp the situation, Maleme airfield in western Crete fell to the Germans, enabling them to fly in reinforcements and overwhelm the defenders. The battle lasted about 10 days.

Joseph Cotterill of FT Alphaville also pointed out an IMF analysis regarding Argentina's debt swap back in June 2001, i.e. voluntary debt swaps don't work:

Voluntary debt swaps (and debt buybacks) done during a crisis can be likened to the case of an individual who, unable to service mortgage undertaken when interest rates were low, decides to refinance it at a much higher interest rate in exchange for temporary relief...

Key indicators

Here is what I am watching. One of the key paragraphs of the deal reads [emphasis added]:

All euro area Member States will adhere strictly to the agreed fiscal targets, improve competitiveness and address macro-economic imbalances. Public deficits in all countries except those under a programme will be brought below 3% by 2013 at the latest. In this context, we welcome the budgetary package recently presented by the Italian government which will enable it to bring the deficit below 3% in 2012 and to achieve balance budget in 2014. We also welcome the ambitious reforms undertaken by Spain in the fiscal, financial and structural area. As a follow up to the results of bank stress tests, Member States will provide backstops to banks as appropriate.

In other words, the EU is saying, "Portugal and Ireland are out of luck. Don't expect anything from us."

Does the market believe that? Can the Greek contagion be arrested? Consider the yield of the 2-year Portuguese paper shown below (click to enlarge). While rates have ticked down, they are still substantially above the levels in late June, before this latest round of anxiety broke. Can the yields at least come down to those levels?

The same could be said of the 2-year Irish note. Click to enlarge:

...and Spanish paper. Click to enlarge:

I think that the all-clear can be sounded when yields for peripheral Europe retreat and stabilize. Until then, the risk premium on the Greek contagion remains a concern.