The Grand Greek Finale

There is no other way to read it; German finance minister Wolfgang Schaeuble have practically given the Greek government an ultimatum, and if the conditions are not met in due time “further measures” must be taken. I can not imagine that these measures would involve further financial aid.

“The markets could try to force the hand of Greece and its EU partners well before this date. More volatility lies ahead.”

Gavan Nolan

Wolfgang Schaeuble, the German finance minister, was referring to Greece’s forthcoming fiscal audit by the EC/ECB, and the steps that EU would need to take if the country’s debt sustainability was called in to question.

“Of course, the markets have been doubting Greece‘s solvency for some time, and they duly took Schaeuble’s comments as a clear sign that the long-awaited debt restructuring was imminent. Never mind that Schaeuble went on to say that any restructuring before 2013 (when the ESM comes into effect) would be voluntary,” credit analyst Gavan Nolan at Markit Credit Research writes in his weekly summary.

He also points to the fact that it is hardly a certainty that “further measures” means restructuring and not more of the same austerity policies.

These caveats didn’t prevent Greece’s spreads hitting record levels on Thursday, and they continued to widen on Friday.

It will be interesting to see what happens when markets opens again after the weekend in a few hours.

Too Stressed To Test

“The sovereign’s credit curve is now steeply inverted, implying that the probability of a near-term credit event has increased. But it is uncertain that a voluntary restructuring would trigger a CDS contract.”

It is also doubtful whether private creditors would participate in such a restructuring.

“European banks, the main holders of Greek government debt, would crystallise losses on bonds held in their banking books, which aren’t marked-to-market and won’t be examined in the upcoming stress tests,” Gavan Nolan notes.

But there is little doubt in the market that Greece will restructure its debt by at least 2013, if not sooner.

Germany’s deputy foreign minister Werner Hoyer said Friday that a Greek debt restructuring “would not be a disaster”, although he made it clear that he was referring to a voluntary arrangement.

Greece has already declared that is unlikely that it will be able to access the capital markets in 2012.

“That this known means that the markets could try to force the hand of Greece and its EU partners well before this date. More volatility lies ahead,” Nolan writes.

Schaeuble’s intervention sparked some life into CDS trading on Greece, Friday.

Markit’s Liquidity Metrics show that after a significant drop from mid-March in the number of CDS quotes there was a spike upwards Thursday, though the quote numbers remain some way off March levels (see chart above).

The turmoil around Greece has taken some of the attention away from Portugal, the most recent country to request a bailout.

The sovereign’s spreads have exceeded 600 bp’s today, with Greece’s travails no doubt contributing.

The Finnish Interference

But events on the other side of Europe may also be playing a part, according to Markit Financial Information.

Finland is to hold a general election on Friday, and the outcome could have a bearing on whether Portugal will receive funds from the EU.

“The True Finns party, a eurosceptic outfit formerly on the fringes, has gained ground in recent months on the back of its opposition to bailouts. This has resonated with many Finns, who resent rescuing less prudent countries,” Nolan writes.

Finland had its own banking crisis in the 1990s and they managed without external help.

The difference in the relative credit standings of the two sovereigns can be seen by looking at the chart above.

Finland is the world’s third strongest sovereign credit, according to CDS spreads, while Portugal is in the bottom five, trading wider than even Argentina.

Aside from sovereign turbulence, the market has had to digest important inflation data. CPIs in the euro zone and China both surprised on the upside but the US core CPI came in lower than expected.

“Further monetary tightening is probable in the first two regions, though the undershoot in the US index could increase the likelihood of QE2 reaching its full maturity. Along with the unfolding earnings season and the ongoing sovereign drama, the consequences of divergent monetary policies across the world will shape sentiment on risky assets over the coming weeks and months,” Gavan Nolan concludes.

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