Here in the credit markets we’re becoming used to political fireworks on a Friday. Those hoping for a quiet end to the week have been disappointed; the sovereign credit markets tending to display more than a modicum of volatility. Today was no different, though there were indications throughout the week that the conclusion would be eventful. And so it was, with Greece fulfilling its now ubiquitous role as the protagonist in the drama.
The Greek Prime Minister, George Papandreou, bowed to the inevitable today and announced that the government would ask its fellow eurozone members for help. The formal request for assistance will activate the EUR30 billion bailout package agreed by the eurozone earlier this month. That Greece requested help wasn’t a surprise – it wouldn’t have refinanced at current markets rates. But the timing was somewhat unexpected, with EU officials insisting only yesterday that the talks between Greece, the EU and IMF would have to be completed before a decision was reached.
Greece’s spreads duly rallied 70bp to 550bp after the announcement (they were already tightening this morning on short covering). The rest of the sovereign market joined in, and the Markit iTraxx SovX Western Europe index tightened to 105bp from 112bp at the open. But the market did not push on or even consolidate at these levels. Indeed, Greece’s spreads are now trading around 600bp, just 23bp tighter than yesterday’s close. The Markit SovX WE is trading at 113.5bp, wider than where it began the day.
Why the underwhelming response to the bailout activation? There are several possible reasons that are being floated around the market. The first concerns implementation. Greek government officials have insisted that the receipt of the funds will be straightforward. Current CDS spreads suggest otherwise. The Greek curve remains steeply inverted, with the short-end refusing to budge from stratospheric levels (see chart above). This indicates that the market sees significant near-term risks.
The other reasons revolve around solvency. Talk of a debt restructuring has gained ground in recent days, helping to push spreads wider. As long as it was voluntary it shouldn’t trigger the CDS. But it would damage Greece’s reputation in the capital markets and would be a de facto default. The negative CDS-bond basis has widened sharply over the week, indicating that bondholders will suffer compared to long synthetic positions.
And then there is the question over whether the the bailout will be sufficient. It should certainly see Greece through this year but the sovereign faces significant refinancing needs in the following years. Many doubt that its fiscal position will have improved enough by then to enable it to tap the capital markets.
The uncertainty has created a contagion effect across the peripheral eurozone names. Portugal has widened sharply and its curve is now inverted (see chart above). Spain and Ireland are also coming under severe pressure, the latter not helped by Eurostat figures showing its 2009 budget deficit in excess of 14%, the worst in the EU.
And its not just the peripheral names widening in the eurozone. Belgium has lost ground this week on news that its coalition government has collapsed. The country has a permanent rift between its French and Flemish speaking peoples, and it is this that has plunged it into political turmoil. Belgium is generally regarded as a solid credit but it is one of the most highly indebted nations in Europe and heightened political risk could raise its refinancing costs. For the first time in 18 months it is trading wider than the UK, a country with its own political and economic problems.
All of the negative developments around sovereigns overshadowed positive news on fundamentals. Earnings have been relatively strong and the several economic releases point towards an economy in recovery. Today’s better than expected IFO survey supported yesterday’s Markit Flash Eurozone PMI. This conflict between sovereigns and fundamentals shows no sign of abating by next week.
Markit’s Gavan Nolan wrote this CDS report