The deepening trepidation regarding Greece’s financial predicament has once again weighed heavily on risk appetite over the past 24 hours, with equities and commodities beating a hasty retreat, the euro under renewed assault, and the dollar making hay. The single currency has been especially hard hit – after reaching 1.45 late in New York trading on Tuesday, it is now back at 1.41 early in the London session. Not helping the mood towards the euro was the latest threat from Moody’s, this time directed at the three major French banks; they each have significant exposure to Greece through loans to the private sector and direct ownership of government bonds. Increasingly, the concern is that European policy officials will be unable to prevent a Greek debt default from infecting other highly-indebted eurozone economies such as Ireland, Portugal, Spain, Italy, Belgium and France. Also contributing to the uncertainty was a threat by current Greek Prime Minister Papandreou to form a new government in order to gather sufficient support for his austerity measures. Time is running out for Papandreou, as he needs to get parliamentary approval for fresh budget cuts and asset sales to ensure that the EU and IMF supply the financial lifeline that the country needs to prevent default.
Guest post by FXPro.
This latest episode of Europe’s debt crisis has triggered further risk avoidance, with losses on the major bourses in the US and Asia overnight of a little under 2%. The correction in equities over the past two months is beginning to look much more substantial now – the S&P 500 has lost 7.5% from its high, while the Hang Seng, the ASX 200 and the Shanghai Composite are down more than 10%. Commodities have not been spared – Brent crude was testing $120 yesterday morning, but it collapsed late yesterday and is now down at $114. High-beta currencies likewise have suffered – the Aussie is not far from 1.05 now having been above 1.07 yesterday morning, while the Norwegian krone has lost 3% over the same time period. Making hay against this much darker backdrop is the greenback, with the dollar index up 2% in the last two days. This is despite the troubling lack of progress regarding the US fiscal debate and debt-limit issue.
The Greek debt showdown. Tuesday’s emergency eurozone finance ministers’ showdown meeting failed to agree on the shape of a second Greek bailout package but, in truth, such is the entrenched nature of the positions being adopted by both sides that a rapid compromise was never likely. For the pessimists, the inability to come up with an agreed solution, the admission that a deal may not be finalised until early July and the concern that this delay could jeopardise or at least delay the payment of the next tranche of IMF money has provided the euro bears with fresh ammunition. For the optimists, there is potential encouragement in that both sides seem to be exploring ways in which each can achieve their objectives. The ECB and France remain determined to avoid a Greek default, while Germany is demanding private sector burden-sharing. It might just be possible to find a middle way that prevents default but at the same time enshrines private creditor involvement, although any compromise would likely be a fudge and merely skirt over far weightier issues.
To some degree, this debate is superfluous, in that Greece is becoming ever more insolvent. Tuesday’s latest budget deficit figures confirmed that talk of fiscal consolidation in the country is just plain nonsense. Tax revenue for the first five months of this year fell by more than 7% versus the comparable period of 2010, and moreover the budget deficit for the period actually widened. Very simply, if Greece cannot even collect enough taxes to pay for current spending, then it has no chance of paying off its growing debt which is set to reach at least 160% of GDP this year.
For all the talk about debt re-profiling, debt swaps and voluntary participation, the basic fact is this: Greece is bankrupt, and it will only accumulate more debts (that is, become more insolvent) unless there is miraculous progress on state asset sales. Debt restructuring, involving substantial haircuts and extension of maturities surely cannot be postponed any longer. Yes, this will be a default, but frankly Greece has no capacity to pay back its huge debts and lost this ability long ago, so surely a declaration that it has defaulted is merely a formality. Many of the larger banks in Europe are already haircutting their Greek bond exposure in their trading books, as they should.
Default would of course have huge ramifications for the Greek banking sector, a large holder of Greek government bonds. As such, default would decimate their capital reserves and probably trigger a much faster run on bank deposits than has taken place thus far. Also, the ECB has stated that it will not be prepared to accept defaulted Greek bonds as collateral – Greek banks have posted some EUR70bn of these bonds in exchange for ECB liquidity thus far. Very quickly, therefore, a Greek default could result in the collapse of many local banks unless there is a huge capital injection from Europe (which is unlikely). A Greek banking collapse may then provoke similar concerns amongst depositors in other highly-indebted economies such as Ireland and Portugal. Little wonder eurozone finance officials are working so hard to prevent a Greek default.
Eventually, however, it becomes impossible to stop the financial dominos from falling over. We may well have reached that point of no return.
French banks rating threat on Greek debt exposure. Moody’s yesterday took the obvious step in the light of the rapidly deteriorating situation in Greece by warning that three of France’s largest banks may need to be downgraded because of their debt exposure to the troubled eurozone member. BNP Paribas, SocGen and Credit Agricole will all be examined by Moody’s to see whether their current ratings are justified in the likely event of a Greek debt default or restructuring. French banks have a significant exposure to Greece, both in terms of direct holdings of government debt and loans to the private sector.
UK labour market in state of flux. Despite the severity of the UK downturn in 2009, the impact on employment was relatively muted compared to previous recessions and also in comparison to the US. Here, the peak to trough drop in employment was around 2.5%, whereas in the US it was nearer 6%. There are two major implications of this. Firstly, the recovery in employment was never going to be that dramatic, given the evidence of labour hoarding. Secondly, the hit to productivity was going to be tough as workers were underemployed. We continue to see the impact of these two factors in the labour market numbers. Employment is rising on the wider labour force measure, having made up around half of the aforementioned peak to trough decline. Today’s numbers showed employment rising 80k in the three months to April, which is 1.3% higher vs. a year earlier. At the same time, output per hour in the whole economy was falling marginally in the final quarter of last year. Although more up to date figures are not yet available, there are strong reasons to believe that there was no great reversal in the early part of this year. The other reason for caution regarding these numbers is the rise in the claimant count measure (up 19.6k) for the third consecutive month. But for the MPC, even though there may be a trumpeted fall in the labour force measure of unemployment, there are no signs of wage growth coming through, with core average weekly earnings (at 2.0%) rising at the slowest pace for nine months. This is going to put real wage growth at -3% before long, as CPI heads to 5.0% and quite possibly higher. The hit to real incomes from high inflation could become the bigger talking point before long.