Greece Again

By Eoin Fahy , Wednesday, 5th May 2010 | 0 comments

A lot has changed in the financial markets since my last update yesterday morning.  At that time, markets had shown quite a muted reaction to the EU/IMF rescue package for Greece.  But from around lunchtime yesterday (Tuesday), the market reaction worsened dramatically.

As of 3.30pm on Wednesday, Greek 10-year bond yields are back up to 10.5%, just a touch lower than the worst point they had reached even before the rescue package was agreed.  Irish bond yields are 5.4%, the highest this year though still slightly better than the worst point reached last year before tough budget measures were announced.  Portugese yields are 5.8% - their worst level yet.

And the difficulties were not confined to bond markets.  The euro has fallen to 1.285 against the US Dollar, and 0.85 against Sterling, while European equity markets are typically down around 1%, following larger falls yesterday.

Concerns

At this stage, the issues that markets are worrying about seem to change daily.  Today, markets have two main concerns.

The first is that the cuts imposed on Greece are just too tough, and will cause either the overthrow of the government, or changed government policies, leading Greece to default on its debts.  The current strikes in Greece don't help those concerns, nor do (emerging) reports that tragically there have been deaths in a bank set on fire by rioters.

The second is that Portugal and Spain, and perhaps Ireland, may also need EU/IMF rescue packages not necessarily because those countries have particularly poor economic fundamentals as international bond investors just don't want to buy their bonds at any price, given the extent of volatility in the market at the moment. Spain, however,  is such a big economy (unlike Portugal, Greece or Ireland), that even Germany and France and the rest of the eurozone countries just might not have enough funds available to put together a rescue package for Spain.

ECB Action Required?

So what happens next?  Various suggestions are doing the rounds at the moment, most relating to what the ECB should, or might, do. 

  • It could cut its key interest rate, but really that would hardly make much difference. 
  • It might announce that it is going to buy government bonds on the market.  This would push down bond yields, and help governments who are having problems raising funds.  But it is quite probably illegal, and it would most likely involve the ECB in deciding which government's bonds it would buy, which would be a hugely political decision in which the ECB would hate to get involved (if it just bought all government bonds across the board, most of the money would go towards buying bonds in countries like France and Germany, which would hardly make much difference to the countries in trouble like Greece and Portugal). 
  • Another suggestion is that the ECB could take "technical" measures to provide liquidity to the banking system, as they did in the aftermath of the Lehmans crisis. 

Sentiment vs Logic

In many ways we are seeing a classic battle between hype and sentiment ("sell everything!"), and logic/rationality ("the macro fundamentals aren't that bad, and Greece doesn't need to borrow a cent for the next two years, so what are we worried about?").  The benign scenario is that logic ultimately wins out.

If sentiment continues to drive markets, however, we may need to see further decisive action from the authorities.

Stay tuned!

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