Market Review 13 April 2010

The financial support package for Greece announced by EU officials on Sunday was larger than expected at about €40 billion and is enough to cover Greece’s financing requirement for this year.  Furthermore, the IMF and EU are to hold discussions today about providing up to an additional €40 billion for 2011-2012.  The EU has not yet required Greece to initiate further fiscal tightening measures beyond those already announced to be eligible for the programme.  Crucially, contrary to market concerns, it seems that the support programme does not require Greece to restructure its debt.  It also seems that Germany is supportive of the package.

It is important to note that the programme remains contingent upon Greece requesting it, which Greece has not yet done.  The Greek Finance Minister has said “The Greek government has not asked for the activation of the mechanism, even though this is already immediately available … the aim is to continue to borrow unhindered on the markets.”  Greece plans to auction T-bills this week.

For 2010, the euro area countries have offered €30 billion in loans and the IMF is expected to add 10-12 times Greece’s quota for $1.25 billion.  Variable rate loans would be made on the basis of three-month EURIBOR rates, while fixed rate loans will be based upon the rates corresponding to EURIBOR swap rates for the relevant maturities.

A spread of 300bps plus a one-time service fee of a maximum of 50bps will be added to these base interest rates.  Any loan with a maturity greater than three years would require an additional 100bps spread.  EU officials have stated that they expect this to translate into interest costs of about 5%, which would be below what is assumed in Greece’ budget.

Knowledge that the Greek Government has been offered credit on these terms has prompted sharp falls in Greek sovereign yield spreads, particularly at the short end of the maturity-range, and somewhat less dramatically declines in spreads for maturities longer than two years.

Greek 10-Year Bond Yields

Some of the problems that have bedevilled the long negotiations leading up to the latest euro zone proposal remain.  It is not clear that lending from one euro zone government to another, in the circumstances surrounding the Greek debt crisis, would be legal, despite euro zone leaders’ assumption that their willing it makes it so.  It would not be surprising if there were a constitutional challenge in one or more member-states.

More immediately of concern is the sensitivity of German public opinion to the idea of a Greek bail-out.  This is evident from official German comment today which stressed that Greece had not asked for aid, that a summit agreement would need to take place before the proposed aid plan could be activated and that the conditions for providing aid were not automatic but subject to discretion.  In other words, Germany still has the right to say ‘no’.

The EU Commission has contested whether a summit would be needed to trigger a loan to Greece, a difference of view with the German Government that opens up the prospect of another stand-off between Germany and its partners on this issue.  All the same, it is probably becoming increasingly clear to German voters that, ultimately, Chancellor Merkel does not intend to say ‘no’.

It is still not completely clear where the IMF is expected to fit into the picture.  The situation may become clearer after today’s talks in Brussels between IMF, EU Commission, ECB and Greek government officials.

If Greece faces euro zone credit costs higher than those in respect of loans from the IMF, Mr Papandreou and his colleagues have a strong incentive to turn for finance to the IMF rather than to their euro zone partners.  Their problem is that the IMF may be unwilling to supply credit on the required scale.  While commenting on euro zone assistance, a ‘senior Greek financial official’ made a revealing slip yesterday in saying a logical size for an aid package would be €80 billion over three years.  This number was hastily corrected to ‘significantly higher than €40 billion’, presumably after it became clear that was all that would be on offer.

The bottom line is that the Greek problem has moved on.  Risks remain but, at the very least, these will likely ensure that the ECB’s monetary policy stance remains relaxed. The euro has strengthened somewhat but we would not hold our breath for too long.  Any fiscal measures are likely to be deflationary over the medium-term.

Meanwhile, across the Atlantic, last week’s US economic data extended its stronger streak.  The non-manufacturing PMI and ISI retailers surveys exploded into unprecedented upside territory. We now await the results of the first quarter earnings reporting season in the US.  Expectations have been gently rising in recent weeks, although that has not been reflected yet in official analyst estimates.

The ‘whisper’ on the street is stronger than the estimates.  Suffice it to say most of the macro economic factors that one might need to project corporate profits are working to lift both first and second quarter profits in the US – unit labour costs, the global recovery, credit markets and the yield curve.  These are quite a dynamic combination of factors.

The risks, though, remain in the US.  ISI’s homebuilders’ survey has dropped quite sharply in the last four weeks and 30-year mortgage yields in the US have risen to over 5.2% following the US Federal Reserve’s withdrawal from that market.  M2 in the US declined $12 billion last week, slowing to a just positive 1.5% growth year-on-year.  There needs to be some substantial improvement in the months ahead.