Darker and darker

July 24, 2012

Moody’s put Germany on notice that it might cut its credit rating and did the same for the Netherlands and Luxembourg. It cited a growing chance that Greece could leave the euro zone, and the contagion and costs that could flow from that, as well as the possibility that Berlin might have to increase its support for Italy and Spain. Both are self-evident risks and markets have not really reacted though it’s interesting timing that Spanish Economy Minister de Guindos is meeting his German counterpart, Wolfgang Schaeuble, in Berlin later. The Moody’s warning could also feed into darkening German public opinion about the merits of offering any more help to its sick partners.

German Bund futures opened just 10 ticks lower and European stocks edged higher after a sharp Monday sell-off. A jump in China’s PMI index has helped sentiment a little. The euro remains on the back foot but if it continues to fall that should actually help euro zone economies, making their exports more competitive. We’re programmed to treat government statements with scepticism but it’s hard to argue with the German finance ministry which said last night that the risks cited by Moody’s were nothing new and the sound state of German public finances was unchanged.

Nonetheless, reminders of the depth of the debt crisis are close at hand. So dislocated is the Spanish debt market that is hard to gauge what costs Spain will be required to pay at today’s T-bill auction because a combination of summer holidays and worries about the country’s finances mean trading has virtually dried up. With benchmark bond yields hitting euro-era highs on Monday, however, the debt sale of 3 billion euros in 3- and 6-month bills is likely to be expensive.
Also last night, clearing house LCH.Clearnet SA  increased the cost of using Spanish and Italian bonds to raise funds via its repo service, which could put further upward pressure on already surging yields.

The trump card that Spain had – that it had issued well over half the debt it needed to in the first six months of the year – has disappeared with its 17 autonomous regions needing to refinance 36 billion euros of debt this year and many in no shape to do so, plus the looser deficit targets granted by the euro zone meaning debt can stay higher for longer. The sovereign bailout that Madrid and its euro zone partners have been striving to avoid, looks more and more likely.

Back to the Greek risk: The troika of EU/IMF/ECB inspectors returns to Athens. The euro zone has said it will keep Greece afloat through August while the inspection takes place but no one is quite sure what happens if the conclusion, the only rational conclusion, reached is that Athens needs more time and money to meet its bailout targets. The new Greek government is trying to highlight a deeper than expected recession for throwing it off course while its lenders say it is failing to push through privatizations, market liberalization and tax reforms. The government has failed so far to find nearly 12 billion euros of extra cuts stipulated by its agreement.
Prime Minister Antonis Samaras is seeking an extra two years to make the cuts and reforms demanded of him. So far, there is little indication he will get it. In the end, it still looks more politically and economically palatable to cut Greece some more slack rather than push it towards default but nothing is certain.
And let’s be clear, in this equation time is money. To give Athens an extra two years would effectively cost an extra 40 billion euros, according to some estimates, and who is going to stump that up?

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