Positions in Europe: Long British Pound (FXB); Short Spain (EWP)
What a difference a day makes! Yesterday, European equity markets closed up between +40 to 150bps; today they’ve given back all of this gain (and more) as headline risk continues to govern market performance. Today’s European headline is very much a continuation of the discussions had over the weekend by European finance ministers, namely the prospect that Greece may need a significant restructuring of its government debt to stay “afloat”; however new statements today have sent Greek (and Portuguese) bond yields and the cost of insuring debt (sovereign CDS) to all-time highs.
The Greek 10YR bond yield jumped a full 30bps day-over-day to 13.2% and the yield spread over German bunds reached 984bps, a new all-time high – eclipsing even the spread in early May 2010 when the country received its €110B bailout. Equally, Greek CDS rose 45bps d/d to an all-time high of 1105bps. The Portuguese 10YR yield continued its expedient upshot today, rising 11bps d/d to rival Ireland at 9.0%, as a bailout package (~80B EUR) for Portugal remains imminent on the backdrop of an interim government that has called new elections for June (see charts below).
The news today included interview statements made by German finance minister Wolfgang Schaeuble to the German newspaper Die Welt that investors holding Greek bonds could face losses after 2013, when the temporary bailout fund that includes Greece’s rescue package expires. Further, Greek finance minister George Papaconstantinou said Greece may be unable to return to financial markets next years. These statements come ahead of potential announcements this Friday by Greece on alternative fiscal solutions to calm investors. Looking further out, June remains an important catalyst date when both the IMF and European authorities will review Greece’s “debt sustainability”.
As always, Greece remains squarely mired between debt as a % of GDP that is expected to ramp to 159% in 2012, and a target from PM Papandreou and Co. to reduce the country’s deficit from a high of 15.4% of GDP in 2009 to 3% by 2014 – which we’ll think they’ll come short of. The government is working against €13.1 Billion in debt (principal and interest) due in the months of April and May, of the some €42.5B due this year.
For us, the Greek “news” comes as no surprise: we’ve long said that the Keynesian Endgame that comprises European and IMF funding and subsidization of member states through more relaxed lending requirements in order to preserve the Eurozone as an entity will not end well. In fact, these bailouts are mere band-aids to calm shorter term market fears, and ultimately fail to instill (or address) the necessary response from country leaders to tackle and set longer-term plans for fiscal and economic health. In any case, the strong equity market moves made by the peripheral countries in the beginning part of 2011 are now seeing significant mean reversion.
Conclusion: European markets will continue to be volatile as the sovereign debt contagion runs its course, which we think could take at least 3-5 years. Managing risk will be an exercise based on duration. We’re comfortable largely being out of the way of this contagion risk, though we’re presently short Spain via the etf EWP. In Europe we like countries with sober fiscal standing (Germany, Sweden, Netherlands), which we think offer an attractive growth profile coupled with a defensive stance among sovereign debt contagion across the region.
Matthew Hedrick
Analyst
