The European Credit Markets Smell PIIGS

Position: Short the Euro via FXE

 

As we noted in our post “Politics vs. Pragmatism” last week, despite the decision by the EU and IMF on 3/25 to “safeguard financial stability” in Greece, sovereign debt imbalances (especially among the PIIGS) remain at large and continue to heighten investors’ fears.  Regarding Greece, most recently credit markets are clearly indicating heightened risk via rising bond yields.

In the first chart (below) we highlight that since 3/25 the yield on the 10YR Greek Bond has jumped a hefty 25bps. And while 10YR yields for the other PIIGS have held pretty steady over the last weeks (chart 2), we’d expect to see them to push up in the coming weeks as Greece shares more of the “sovereign debt” spotlight. Note that Portugal’s credit rating was recently cut to AA- by Fitch Ratings; we’d expect to see a downgrade of Spain in the coming weeks. For reference on the total debt and budget deficit constraints afflicting the PIIGS, see chart 3.

Where else is this fear showing up?

  • The equity markets of Spain, Greece, and Portugal are among the worst global performers YTD, down -7.3%, -4.6%, and -3.6% respectively.
  • Moody’s downgraded five of the nine Greek banks it tracks yesterday, saying the “country’s weakening macroeconomic outlook and its expected impact on these banks’ asset quality and earnings-generating capacity.” (a lagging indicator, but representative of consensus).

As we’ve said before, the lack of policy from the European Community to address the sovereign debt issues of its member states will continue to shake markets. We’re currently short the Euro versus the US dollar via FXE in our model portfolio, trading a range of:  buy/cover at $1.32 and sell/short at $1.36.

Matthew Hedrick

Analyst

The European Credit Markets Smell PIIGS - e1

The European Credit Markets Smell PIIGS - e2

The European Credit Markets Smell PIIGS - e3