This week has seen various developments in the UK economy and I wrote on those on Monday and Tuesday. However there have been moves and developments in the euro zone too particularly in the sphere of peripheral sovereign bonds,credit ratings and inter-bank markets. Sound familiar? Interestingly this time the euro is rallying whilst these play out as opposed to falling and just as interestingly so are global stock markets which have just had seven days of rises overall,albeit hidden slightly in the UK because we do not have a FTSE 99 index. Those (journalists) who are absolutely confident that some events led to other might do well to observe this fact that there is not the direct causal link that many of them have implied. On the subject of stock markets after last nights more than 200 point rise in the Dow Jones Industrial Average it is now 21 out of the last 30 days that have seen a triple digit move on a closing basis. Now that I do see as a symptom of these times, and not particularly a good one.
I have written over the last week or ten days about the way that Greek government bond yields were edging higher again and after going above 8% at the ten-year maturity had reached 8.3%. Considering the scale of euro zone firepower with the “shock and awe” SPV in the background and outright buying of Greek government bonds by the European Central Bank in the foreground you might think that this was not an inspiring result and I would agree with you.
Late on Monday the Moodys ratings agency as I mentioned yesterday downgraded Greece’s government bond rating by four notches from A3 to Ba1, and it also reduced Greece’s short-term issuer rating from prime to not prime. Moody’s offered some analysis of the situation with its downgrade according to the Financial Times.
“The Ba1 rating reflects our analysis of the balance of the strengths and risks associated with the Euro zone/IMF support package. The package effectively eliminates any near-term risk of a liquidity-driven default and encourages the implementation of a credible, feasible, and incentive-compatible set of structural reforms, which have a high likelihood of stabilizing debt service requirements at manageable levels,” says Sarah Carlson, Vice President-Senior Analyst in Moody’s Sovereign Risk Group and lead analyst for Greece. “Nevertheless, the macroeconomic and implementation risks associated with the programme are substantial and more consistent with a Ba1 rating.” She is unconvinced over time how the reforms will play out and adds ““This uncertainty represents a risk that leads Moody’s to believe that Greece’s creditworthiness is now consistent with a Ba1 rating, a rating which incorporates a greater, albeit, low risk of default.”
So Moodys is afraid of the d word or default. In other words the question it is posing is what happens after the euro zone and ECB pack their bags and go home? A deeper question might be can they go home? However only events playing out can answer this question. On a related topic there is an IMF team in Athens right now going through Greece’s national accounts as part of the conditionality of the aid given her. If they should decide that she is not fulfilling her side of the bargain then the next payment of funds from the EU/IMF support package due in August will not be paid. Some more excitable blogs think it is likely that this will happen. Personally I feel that the IMF auditors will be under enormous political pressure and if they do uncover problems the result will be that it is hushed up for now and further pressure will be put on Greece to comply. There are a lot of vested European political interests at play here.
Implications of Moodys move.
1.Greek government bonds will attract an extra 5 per cent penalty when banks use them as security for ECB funds because of Moody’s action. The extra haircut means commercial banks will receive less money for Greek bonds than for bonds from any other euro zone nation. An irony of this is that to maintain their current positions they will have to deposit even more Greek government bonds with the ECB, which will further weaken its credit position on average. In case you are wondering it is estimated that Greek commercial banks have deposited some 85 billion Euros of Greek government bonds with the ECB in return for funding.
2. Moody’s move forced some bond investors to offload the country’s debt. You see some investment funds track indices that have credit rating limits that no longer permit the holding of Greek government bonds. For example they will not be eligible for Barclays Capital’s Global Aggregate, Global Treasury, Euro Aggregate and Euro Treasury Indexes. In something of an irony Greek government bonds will be eligible for some emerging market and junk indices,however this is hardly a source of pride as it returns Greece to where it was when it joined the Euro 9 years ago! Also the net effect will be sales of Greek bonds.
The effect of these moves has been quite striking. Last night according to Reuters Greek ten-year government bond yields closed at 9.35% which is back to crisis levels. Greece also has a three -year government bond which is used as a benchmark and this closed at a yield of 9.5%. On May 10th after the announcement of the 750 billion Euro SPV and the commencement of ECB purchases of peripheral sovereign debt the respective yields were 8.26% and 9.09% respectively. This is not quite my definition of “shock and awe” anymore and poses a real challenge to euro zone policymakers.
On the subject of euro zone policymakers regular readers will be aware that no action in this crisis can take place without an official from the euro zone believing that spouting absolute rubbish will improve the situation. In this instance step forward Olli Rehn.
“Moody’s decision does not in any way take into account Greek commitments or the negative consequences, which were considerably reduced following the adoption of the (bailout) programme,”
If you simply read their statement above you can see that Moodys specifically mention that they did.
As to ratings agencies and Moodys in particular then the timing of this move does them no great credit (and of course they are starting from a low base). After all if Greece is Ba1 with European support and financing what was it back in April when it had no European support and had taken fewer austerity measures? The only possible conclusion is that Greece was weaker but Moodys did nothing. In a way this is an apt analogy for the failures of ratings agencies.
Spain and the effects of contagion
I have written several times recently about the way Spain is being sucked increasingly into the sovereign debt crisis, for example I wrote about her cajas or savings banks on the 24th May and her general situation on the 31st May. In general her banks are struggling to be able to fund themselves in inter-bank markets particularly if you exclude the big two Santander and BBVA. There was some official acknowledgement of the problem on Monday when Carlos Ocana who is Spain’s Treasury secretary said that the credit freeze affecting Spanish banks and corporations was “definitely a problem”.
Perhaps the clearest sign of the stress in the country’s financial sector is the fact that its banks are borrowing record amounts from the European Central Bank because they are unable to raise funds in the private markets. It is being reported that Spanish banks have raised a record €85.6 billion in ECB funding. To put this into context this is double the amount lent to them before the collapse of Lehman Brothers in September 2008 and 16.5 % of net euro zone loans offered by the ECB which compares to the fact that they are 11% of the banking system by size.
Just at this moment the German newspaper Frankfurter Allgemeine Zeitung joined the debate and suggested that the euro zone was planning a bailout for Spain. This is hardly going to improve things although it perhaps ignores the fact that so far Spain as a country has a debt to GDP ratio which is much better than Greece’s.
However Spanish government bond yields have pushed higher this week and her ten-year yields are now 4.8% which is 2.11% over that of Germany’s equivalent. Again if we compare to the “shock and awe ” date of May 10th they were 4% and that is quite a difference. So far this week Spain has raised some short-term money at a rates around 0.7 and 0.9% higher than past issues of the same maturity. So not good but not a disaster. We will find out more later this week as she has some longer dated bonds to issue.
It is starting to feel as if the problems which originated in her property and banking markets are beginning slowly to catch up with Spain. There is an irony that her new austerity programme is by weakening prospective economic growth not helping her image as much as it might. So far she is able to cope with the situation but the policymakers of the euro zone do have a problem with her and Greece as in spite of the ECB buying 6.5 billion Euros of peripheral government debt over the past week yields are rising.
As to the SPV my thoughts turn to a problem with it that I wrote about from the beginning. Spain is responsible for 53.9 billion Euros of the funding. Should she have to draw from the fund how does that work exactly? If conditions continue to deteriorate I suspect that this question will occur to others too.