While markets remain fixated with the debt ceiling debacle in America, I am more concerned with Europe. We’ve had just two days of gains in European sovereign bonds and already the yield blowout has resumed. Both short term and long term Italian bonds were under pressure overnight:
The same for Spain:
It was the same story for the other PIGS. Now, correct me if I’m wrong, but the Eurozone’s breakthrough agreement, which represented the first real serious attempt at a transfer union, mostly at the level of bank support, should be offering better results than this. So why not?
The first and most obvious reason for last night’s action was the response of the ratings agencies. From the FT:
The second bailout of Greece will weaken the credit ratings of Italy and Spain as well as resulting in a default for Athens, Moody’s said on Monday.
The US rating agency downgraded Greece by three notches to Ca, Moody’s next-to-lowest rating and one that implies the country is “very poor or in default”.
But it also warned that, in spite of reducing contagion in some ways, last week’s set of measures to shore up the eurozone could lead to downgrades of creditor countries not rated triple-A because of the precedent for future bail-outs.
“For creditors of such countries [Greece, Portugal and Ireland], the negatives will outweigh the positives and weigh on ratings in future,” Moody’s said.
… Moody’s said the second Greek bail-out announced last week was credit-neutral for Portugal and Ireland, the two other eurozone countries that have had international rescues, as well as for triple-A creditors such as Germany and France. But it would be “an additional negative to be taken into account” for non-triple-A creditors with big debt burdens or budget deficits, according to Alastair Wilson of Moody’s, hinting at Italy and Spain.
Fitch, another rating agency, warned last week that the Greek bail-out would probably serve as a template for any future bail-out of Portugal and Ireland.
Gary Jenkins, head of fixed income at Evolution Securities, said: “Call it a self-fulfilling prophecy or a vicious circle, but the rating agencies’ comments suggest that the likelihood is that over the medium term contagion has been increased by the events of last week rather than decreased.”
Moody’s added that following any Greek debt exchange it would review Athens’ rating anew. But it poured cold water on hopes that it could be lifted significantly. “While there is some debt reduction, we see the debt trajectory only being slightly lower,” said Sarah Carlson, a Moody’s sovereign risk analyst. Greece’s debt is the highest in the eurozone and is expected to peak at 172 per cent of GDP. Nicolas Sarkozy, France’s president, said the bail-out would cut that by 24 percentage points.
On top of that news, Italy cancelled its scheduled August long bond sales:
“considering the large cash availability and the limited borrowing requirement,” the Treasury said in a statement Monday.
The 12-month Treasury bills will be offered, it said. The T-bill auction is scheduled August 9.
But the big problem is that although EU politicians have taken a theoretical step towards a transfer union of sorts, in classic eurozone style, it looks incredibly unwieldy. From Alphaville:
From Jacques Cailloux and his team at RBS.
1. Greece Bail Out II now detailed, rolling crisis still likely … The political will of some countries to get PSI at any cost won the day which will have a number of negative side effects (rating downgrade for Greece and potentially other countries, ECB requirement for additional guarantees for Greek collateral, market perception that PSI might be a template for other countries) while not bringing substantial economic benefits. Indeed, after almost 3 months of negotiations and effort, the Greek debt load will be at best reduced by 10 to 20 percentage points of GDP to what will still be seen as an unsustainably high level…
2. Toolkit to respond to euro area contagion rushed out: The statement clearly gives the impression that euro area policy makers are increasingly ‘getting the message’, with 3 new tools being created: a precautionary programme, a lending facility for non programme countries to recapitalise banks and a bond buying programme in the secondary market. However, the level of detail provided is low…there is insufficient information available to tell how preventive those tools will end up being deployed and this is related to the lack of clarity surrounding the so called “appropriate conditionality”…
Indeed, intervention in the secondary bond market will be on the basis of an analysis by the ECB and then a “decision by mutual agreement of the EFSF/ESM Member States, to avoid contagion”.
3. Nice tools but no firing power: In our view a key limitation of the announcement is that it did not address the size of the EFSF…under the amended EFSF which will aim at having a lending capacity of Eur440bn, and given current and likely commitments, the EFSF will be left with a little more than Eur300bn of lending and or buying capacity – a too small amount to restore investor’s confidence that the euro area has once and for all dealt with its sovereign crisis.
Perhaps I’m being melodramatic, but I get the strong sense that markets are accelerating the push for resolution of the European conundrum and politicians and bureaucrats just can’t keep pace. Perhaps it’s that European growth is now being badly effected. From Gavyn Davies:
Meanwhile, in the eurozone, there have also been some early activity indicators published for July. The flash PMI surveys for the entire eurozone were very weak. In addition, the IFO survey for Germany and the INSEE survey for France have also declined, suggesting that the slowdown has now begun to infect core Europe, which was previously immune from it.
Perhaps too, it’s the pressure of the parallel crisis in the US. Equity and commodity markets have held up well to date in my view, and when some resolution arrives to the US debt ceiling crisis no doubt another relief rally will ensue (perhaps short lived given that resolution is likely hammer growth via austerity).
However, my gut tells me that we’re headed for worse sooner rather than later in Europe, and on that note we can finish with a dramatic flourish from the always colourful Ambrose Evans-Pritchard:
They never wavered in their faith that EU states would yield sovereignty to save the euro if push came to shove, that monetary union would force the pace towards joint EU government.
So it proves to be, for now. But let us not forget that Europe’s ideologues have achieved this only by pushing the world to the brink of catastrophe and holding parliaments to ransom with their great gamble, just as the West’s financial elites held parliaments to ransom in the banking crash of October 2008.
That ransom appears yet to be paid.