I sit dazzled at the idea the ECB is going to hike three times smack in the face of a renewed sovereign debt crisis in Europe.
Greek, Portuguese, and Irish government bond yields are at fresh highs and Spanish government yields are flirting with new highs. Topping off recent action, Moody’s downgraded Spanish government debt on bank capitalization concerns and the market once again anticipates a Greek default in spite of a $153 billion bailout.
Let’s take a look at some of the stories making those headlines.
Bond Market Anticipates Greek Default
Bloomberg reports Bond Market Anticipates Greece Defaulting as EU Leaders Meet
Greek 10-year bond yields rose to a record this week and it costs more than ever to insure against a default, even though the nation received a 110 billion euro ($153 billion) bailout from the EU and the International Monetary Fund last year. Two- year yields exceed 10-year levels, suggesting a restructuring may come before the three-year aid program expires.
“The onus is on EU officials to dissuade the market from the notion that a debt restructuring is inevitable,” said Robin Marshall, director of fixed-income at London-based Smith & Williamson Investment Management, which oversees $20 billion. “They’ve lost investor confidence in any resolution that doesn’t involve some form of restructuring.”
EU leaders gather today in Brussels, aiming to agree to a blueprint to improve competitiveness, a plan Germany demanded as a condition for expanding the bailout effort. Investors will also be looking for signs that differences over how to solve the debt crisis are narrowing ahead of a second meeting on March 24-25 that German Chancellor Angela Merkel has said will produce a comprehensive package of measures.
Greek securities plunged this week after Moody’s Investors Service cut the nation’s rating, already at junk, by an additional three levels, saying the probability of default had increased due to “implementation risks” in the budget cuts it is making as a condition of receiving aid.
Yields on the bonds of the euro region’s most indebted nations have jumped in the last two months as Germany, Finland and Austria rebuffed calls from Greece and Ireland to lower the interest rates on rescue loans. Disagreements also persist over the remit of the 440 billion-euro European Financial Stability Facility, which provided loans to Ireland, including whether it should be allowed to buy euro-region government bonds.
Leaders will today debate a proposed pact that Merkel and her French counterpart Nicolas Sarkozy want as part of any reinforced plan to support cash-strapped nations. The bloc’s economically weaker countries have criticized the plan as an attack on their sovereignty.
Portuguese 10-year bond yields reached 7.70 percent on March 9, the highest since at least 1997, when Bloomberg began collecting the data. On the same day, equivalent-maturity Italian yields climbed above 5 percent for the first time since November 2008, while Irish 10-year yields touched the most since February 1993.
“It doesn’t seem like a solution or compromise is around the corner,” said Orlando Green, assistant director of capital markets strategy at Credit Agricole SA in London. “We could see more spread widening if they are slow in coming up with a plan. It’s not all priced in yet.”
Spanish Banks Need to Plug $21 Billion Capital Hole
Spanish banks that together need as much as 15.2 billion euros ($21 billion) to meet minimum capital levels now must persuade investors that their battered balance sheets offer the potential return to match the risk.
Bank of Spain’s estimates of how much capital the banks need fully reflect losses hidden on balance sheets, putting the onus on them find investors quickly, said Inigo Lecubarri, a fund manager at Abaco Financials Fund in London.
“At this stage, I don’t think anyone will be really convinced by anything,” said Lecubarri, who helps manage about $200 million at Abaco. “People will only be convinced when someone credible comes and puts some money on the table to invest.”
Spain Irate Over Debt Downgrade
Spain saw its sovereign debt rating slashed by one notch to Aa2 on Tuesday, as Moody’s, the credit rating agency, cited higher than expected recapitalization costs for the country’s savings banks or cajas, and the central government’s inability to enforce ambitious budget deficit targets, set at 1.3% of GDP throughout the 19 autonomous communities. Spanish officials were enraged, starting with finance Minister Elena Salgado, who disagreed with Moody’s decision to release the figures hours ahead of the Bank of Spain’s official estimates of restructuring costs.
The country’s benchmark index, the IBEX 35, dropped 1.17% through the session, while Spanish government bond spreads over German bunds hit 225 basis points, as yields rose to 5.53%.
Moody’s downgraded its rating on Spanish government bonds to the second highest notch on fears that the the cost of re capitalizing the country’s many cajas would probably reach €40 to €50 billion (about $55 to $69 billion). That would be far more than the €20 billion ($28 billion)estimated by the office of President Jose Luis Rodriguez Zapatero and would substantially increase Spain’s public debt ratio.
Spanish officials were infuriated that Moody’s chose to release these numbers only hours ahead of the Bank of Spain’s official estimates, which put banks and cajas’ recapitalization needs at €15.2 billion (about $20.1 billion).
Expect Greece, Ireland Default
At a minimum, Greece and Ireland are going to default. Spain and Portugal are on deck.
ECB Rate hikes penciled in by the market will bring those defaults sooner rather than later. There is merit in defaults sooner because the quicker the defaults, the quicker the recovery. However, the ECB sure does not see it that way.
Thus, things in Europe are about to get interesting even though I rather doubt we see three hikes by the ECB by December.
Mike “Mish” Shedlock
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