Unnecessary, Undesirable, Disastrous –

These are the adjectives Bank of Greece (BoG) governor George Provopoulos used yesterday to describe what has quite evidently become unavoidable. As we noted here last week, the 'debt restructuring' (euphemism for default) of Greece's sovereign debt has lately moved from being 'discussed behind closed doors' to being openly discussed, even if some in the eurocracy continue to cling to the notion that it must be avoided at all costs.


The fact that the governor of the BoG governor speaks out against a default is probably a function of the fact that the national central banks are all part of the 'euro-system' these days, and hence represent the long arms of the ECB. The ECB in turn remains dead set against anything that could expose the banking system and/or its own balance sheet to potentially grievous losses. More grievous, that is, than they already are. On Monday Greece's two year note yield vaulted above 20% for the first time, to 20.34% in a huge 1.832% single day move.





Monday's move in Greek 2 year note yields – click for higher resolution.



In January, the same note yielded slightly over 11%, and as recently as October 2010 its yield made a low at about 7.4%. Clearly, 20.34% is a sign that the markets no longer believe there is any possibility of avoiding a debt restructuring. As we have noted before, even though the ESM bailout provides Greece with financing at a much lower rate, this does not alter the size of the existing mountain of debt or the freight train of unfunded liabilities bearing inexorably down on the Greek government (while the same is true of all other Western welfare states, in Greece's case the figures are especially worrisome). Moreover, with EU/IMF loans enjoying seniority, existing debt has become that much more risky.

The cumulative debt-to-GDP ratio of Greece is estimated to reach about 160% within two years (if unfunded liabilities are included, we get to nearly 800%),  and while the austerity measures are likely to shrink the annual deficit, GDP is at the same time still contracting. Since the likelihood of debt repayment or the ability to tap debt markets for rollovers is gauged by this ratio (which tells us both how much debt reduction there is and how big the effect of inflation on the economy is, given that GDP growth figures are likely to reflect the effect of monetary inflation on prices and little else) , Greece finds itself in an impossible position.


As the WSJ reports:


"[A debt restructuring] is neither necessary nor desirable," Bank of Greece governor George Provopoulos said.

"It would have disastrous consequences for the access of the government and of Greek enterprises to international financial markets, as well as very negative effects on the assets of pension funds, banks and individuals holding Greek government securities."

His remarks, made at the bank's annual general meeting, come as investor concerns over such a restructuring continued to hit European financial markets Monday, weighing on the euro and government debt markets.


But many analysts say Greece's fiscal reforms aren't enough to tackle a debt burden expected to reach nearly 160% of GDP in 2013. In recent weeks, there has been growing speculation that Greece will need to proceed with some sort of debt restructuring to ease that burden.

"Progress with adjustment has been made but is still slow if debt dynamics are taken into account," Mr. Provopoulos said. "What is now needed is a strong relaunch of our efforts, to make up for the delays and give fresh impetus to reform policies."

Mr. Provopoulos also reaffirmed the Bank of Greece's economic forecasts for the Greek economy this year. After two years of recession, GDP is expect to contract by a further 3% this year, although there is a risk it could be lower.

The central bank also sees inflation slowing to around 3.25% this year—down from an average rate of about 4.6% in 2010—but well above the government's 2.2% forecast for 2011.“


(our emphasis)

The disaster for investors is already manifest given the plunge in Greek bonds, but given that some estimates speak of '50% to 70% haircuts' for bondholders  they could certainly grow. That said, for about half of the past 180 years Greece has been in some form of government debt default, so it wouldn't be the first time. We would also note, a debt restructuring will not obviate the need for further belt-tightening and reform. Alas, it would obviously be far better to start afresh with a reasonably clean slate.

The fact that Greece will have to somehow restructure its debt fairly soon has in the meantime been admitted by Mrs. Merkel's parliamentary budget director Otto Fricke, which seems to have hastened today's move in Greek bond yields to fresh highs. Mr. Fricke was reduced to 'hoping that Greece would somehow get through the summer'.

Greece's main union meanwhile has called for a general strike against the government's austerity measures on May 11 as discontent over the policy continues to simmer.

Concurrently, the 'True Finns' party has made vast electoral gains in Finland's elections over the weekend (it got 19% of the vote) and it appears a euro-skeptic (or rather, 'bailout skeptic') coalition will form the new government. As CNN reports, this could mean trouble for the most recent ESM/IMF bailout, namely that of Portugal:


„As a rule, Finnish elections don't tend to generate much international excitement – but last night’s election victory by the eurosceptic party True Finns has turned that rule on its head.

A normally stolid member of the eurozone with billions of dollars of exposure to bailout funds and loan facilities, the new-look Finland could potentially scupper any further bailouts and plunge the euro project into a new crisis.

Here's why: Bailouts – like the EU bailout of Portugal, expected in June – require the agreement of all 17 members. And Finland, unlike its eurozone partners, has to put all requests for bailouts to a majority vote in parliament.

That’s very bad news for Portugal, which just last month became the third eurozone member to ask the EU and IMF for a bailout.“


(our emphasis)

Whether or not the new government of Finland will actually vote down further bailouts remains to be seen, but the evidently this election outcome has made the markets rather nervous. As we noted last week when we asked whether the reprieve was over, this new tendency for governments that have supported bailouts to lose the support of voters is becoming quite widespread – the social mood is clearly deteriorating in Europe. It seems now that CDS spreads and bond yields that have recently declined have indeed bottomed out, and correlations across the euro area in these markets are once again rising. Not surprisingly, both Portuguese and Greek CDS spreads have hit new all time highs.

Most notable and important for the near to medium term future however is the fact that Spain's fortunes are turning with those of the others – and Spain likely remains the big 'make or break' lynchpin of the entire ESM / bailout project. We don't want to leave Italy unmentioned, which may come under a cloud eventually as well. Italy has the great advantage that most of its debt is held by domestic investors, but it is no less in fiscal and economic trouble for that. Italy has managed to 'muddle through' for a long time with its vast debt burden, but in the past it had a currency it could, and frequently did, devalue, a luxury no longer available to it.

Rather incongruously, the ECB has begun to make more hawkish noises on Monday as well. To this it should be noted that monetary conditions in the euro area have lately been tightening rather noticeably. Consider e.g. that the year-on-year growth of euro area TMS has recently plummeted to a mere 3.4%, with the most recent quarterly annualized growth rate at 3.1% and the monthly annualized growth rate clocking in at minus 10.1%.



The year-on-year growth of euro area M 3 and euro area TMS (true money supply, via Michael Pollaro) – the current y.-o-y. growth rates are 1.8% for M 3 and 3.4% for TMS – click for higher resolution.



And yet, remarks made by ECB officials on Monday seem to indicate that the ECB has after all embarked on a more extended rate hike spree than hitherto assumed.

As Bloomberg reports:


„European Central Bank Governing Council members signaled they will keep tightening monetary policy this year to curb inflation as the economy strengthens.

Investor expectations that the benchmark interest rate will be increased by another 50 basis points in 2011 are “well- founded,” Austria’s Ewald Nowotny told Bloomberg News in Washington on April 16. Luc Coene of Belgium said in an interview yesterday that monetary “conditions are too accommodative.”

The suggestion that the ECB will soon raise its key rate again was echoed by other policy makers at the weekend meeting of the International Monetary Fund, even after President Jean- Claude Trichet said this month’s quarter-point boost to 1.25 percent wasn’t necessarily the start of a series. Higher euro- area borrowing costs at a time when the U.S. Federal Reserve is signaling no imminent move in its near-zero policy rate may support the euro after it fell last week on concern Europe’s sovereign debt crisis isn’t over.“


The only economy in the euro area that really deserves to be called 'strong' at the moment is Germany's – for which current interest rates are clearly too low and have set a boom into motion. Alas, if the ECB hikes rates further it will  undoubtedly put more pressure on the peripheral economies – this is unfortunately especially true of Spain, where mortgages are as a rule variable rate loans that are tied to the central bank's administrative rates. We happen to think that an acceleration of the liquidation of malinvested capital in the nations that have been home to massive real estate bubbles can only be salutary for their long term economic health, but it seems likely that the problems besetting both banks and sovereign debtors in the peripheral nations of the euro area will initially intensify if the ECB's goes through with the planned rate hikes. In fact, we expect the ECB to do an about-face once the problems flare up again – which they currently seem set to do.

Given strong growth in euro area TMS in 2009 and parts of 2010, the lagged effect of this previous phase of monetary inflation on prices will likely continue to percolate through the euro area for a while still (this is just a guess, as such lags are variable). This upward pressure on prices is what motivates the ECB to hike its rates now, but as shown above, money growth is already slowing sharply of its own accord. Hence economic activity is likely to slow down as well in coming months.

As a somewhat humorous aside, Standard and Poors chose this Monday to remind the world of the glaringly obvious – namely that the fiscal debt of the US is also becoming slightly worrisome in terms of both its magnitude and growth rate. Apparently S&P failed to consult the chartalists, as it rudely decided to put the US government's debt on 'negative watch'.

As the Washington Times reports:


„Standard & Poor’s Corp., one of Wall Street’s top ratings agencies, put the United States on notice Monday that it may lose its gold-plated AAA rating if it does not act quickly to pare down deficits ranging over $1 trillion for years to come.

Although Congress and President Obama have offered proposals to slash about $4 trillion from future deficits, S&P said those plans are far apart on how to achieve the budget reductions, and resolution of the differences may not occur until after the 2012 presidential election — not soon enough to prevent a downgrade.

“Looking at the gulf between the parties, it has never been wider than now,” said David Beers, managing director at S&P, noting that Republicans and Democrats are nowhere near agreement on whether to raise taxes or what to do to reform Medicare and Medicaid.

“It takes a lot of political will to bridge this gulf,” he said, and the ratings agency thinks there’s a one-in-three chance it won’t happen, and the U.S. will lose its top credit rating in the next two years.“


We would note to this that the upcoming liquidation of bubble activities once the Fed's 'QE2' money printing exercise stops will likely weaken what appears to be an already slowing economy further. Consequently there is little chance of the government's fiscal gap closing in the near future, quite irrespective of political differences between the parties. There is has been a noticeable drop-off in corporate tax receipts in Qu. 1, which have plunged by 31%. This is usually a sign of slowing economic activity and may be a bad omen for the ongoing earnings season as well.

The Charts:

1.    CDS  (in basis points, color coded)


5 year CDS spreads on Portugal, Italy, Greece and Spain – a rocket ride into new high territory for Greece and Portugal, while Spain and Italy rebound to their highest levels in more than a month (note that we have to keep shifting the y-axis for Greece) – click for higher resolution.



5 year CDS spreads on Ireland, the senior debt of Bank of Ireland, France and Japan. Only Japan's CDS are still coming in – the European spreads have taken back a good deal of their recent decline – click for higher resolution.



5 year CDS spreads on Austria, Belgium, Hungary and Romania, all bouncing in sympathy – click for higher resolution.



The Markit SovX index of CDS on 19 Western European sovereigns – also back at a one month high – click for higher resolution.


2.    Euro Basis Swaps (in basis points) and Other Charts


One year euro basis swap – these swap rates remain well behaved for now.



5 year euro basis swap – also hanging on to most of its recent recovery – click for higher resolution.



5 year CDS spreads on Saudi Arabia, Bahrain, Qatar and Morocco – the recent increase in unrest in Syria may be driving these up again at the moment – click for higher resolution.



The SPX, T.R.'s VIX based proprietary volatility indicator and the gold-silver and gold-commodities ratios. Gold-silver still plunging, but gold-commodities continues to streak higher lately, reaching a three month high. This is a fly in the ointment for the stock market – we have remarked on the signal given by this ratio a few times before and it appears now that it might indeed be meaningful – click for higher resolution.



The SPX and the AUD-JPY cross rate (as a barometer of risk appetite) – the divergences here may turn out to be meaningful as well – click for higher resolution.



From a report by Société Générale, the debt-to-GDP ratios of several European countries plus the US, including unfunded liabilities (2010 estimate).  Severe austerity over an extended period of time would be required in all cases to lower these debt mountains. It seems more likely that it will be attempted to 'inflate them away', as dangerous  as such a course is – click for higher resolution.



Via Markit, the CDS spread on US debt – it used to oscillate between 5 and 15 basis points once, nowadays it fluctuates between 40 and 60 basis points. This is by no means an alarming level, but it does show that market concerns about the debt  have increased somewhat – click for higher resolution.


Charts by: Bloomberg, Société Générale, MarkIt, Michael Pollaro



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