As you are surely aware by now, the European markets took a bashing overnight with the most of the European headline markets heading down by over 3%, Austria lead the way with 4%. We also saw a reversal in periphery bonds with upwards pressure on Portuguese, Italian and Spanish debt. There were two pieces of news last night that did the damage.
The first was the “surprising” news from Eurostat that Eurozone GDP slipped 0.3% which meant overall growth for 2011 was just 0.7% and the area is on the verge of recession. Household spending fell by 0.4%, exports by the same, and imports by 1.2%. There is talk of a “mild recession” but I see little in the available data to suggest that this trend will abate. This just sound to me like more talk from optimistic types who haven’t actually bothered to look at the available macro information.
As far as I am concerned the outcome for the Eurozone in terms of growth was completely predictable because one-sided austerity was always going to lead to a collapse of southern European economies which would inevitably start to bring down the whole ship. I discussed these points once again yesterday.
The fact that we are now seeing contagion into Spain in itself is a huge issue, but possibly not the major one. As I mentioned a few weeks ago, another outcome of Europe’s misguided economic ideology has been the destruction of available political capital. What is needed at this point is a significant change in policy direction to rescue Europe and Spain’s recent rebuke appears to be the beginnings of an attempt at this. But the continued failure of European leaders to deliver a credible and sustainable plan, along with the associated politicking, means that there is now limited political capacity available to support any such move. In my opinion this is a very dangerous situation because the damage done by the current policy failures means that a credible economic plan to fix Europe may well now be politically out of reach.
Although this is something I believe will shape Europe over the coming months, it wasn’t the major point of concern last night. That was once again left to Greece via its financial ministry‘s media unit:
The Republic confirmed that if it receives sufficient consents to the proposed amendments of the Greek law governed bonds identified in the invitations for the amendments to become effective, it intends, in consultation with its official sector creditors, to declare the proposed amendments effective and binding on all holders of these bonds. Consequently, all obligations of the Republic to pay holders of those bonds any amount on account of principal will be amended to permit the Republic to discharge these obligations in full by delivering to the holders of the amended bonds on the settlement date the consideration described in the invitations. In addition, the Republic’s obligation to pay interest on its Greek law governed bonds will be amended so as to reduce the amounts due to interest accrued through 24 February 2012 and to provide that such amounts will be paid by delivering short-term EFSF notes in lieu of cash. No further interest will accrue or be payable on those bonds.
The Republic’s representative explained that the Republic has fixed a delayed settlement date (11 April 2012) for the invitations made to foreign law governed Republic bonds and guaranteed bonds to comply with the notice provisions of those bonds and allow the holders to vote on the relevant proposed amendments prior to the delayed settlement date. Whether or not the proposed amendments to the foreign law governed bonds and guaranteed bonds are approved by the requisite majorities, the Republic intends to accept tenders of these bonds for exchange (assuming the conditions described in the invitations have been satisfied or waived).
The Republic’s representative noted that Greece’s economic programme does not contemplate the availability of funds to make payments to private sector creditors that decline to participate in PSI. Finally, the Republic’s representative noted that if PSI is not successfully completed, the official sector will not finance Greece’s economic programme and Greece will need to restructure its debt (including guaranteed bonds governed by Greek law) on different terms that will not include co-financing, the delivery of EFSF notes, GDP-linked securities or the submission to English law.
In other words, if they get less than 66% PSI involvement they will default fully, if they get less than 100% they’ll CAC. As I explained on Monday either of these paths leads to a credit event and whole new circus act. Given that it appears a number of Greek pension funds have already stated they will hold out, one of these two options is inevitable at this point. The institute of International finance ( the banks ) has estimated the outright default of Greece to cost €1trn. I’m not sure about the validity of the estimates , but you can certainly see why the markets would be concerned about this outcome.
In regards to CDS, Felix Salmon has been doing some interesting work describing the immaturity of the frameworks surrounding credit default resolution and why sequencing of the Greek bond swap is very important in regards to flow-on effects to other sovereigns. I recommend you have a look at the article and attempt to get your head around the importance of the CDS auction procedures.
Let’s see how the markets hold up tonight.