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10 March 2011
Snail-like EU faces breakneck markets over euro debt
By Jeremy Gaunt and Noah Barkin
LONDON/BERLIN | Wed Mar 9, 2011 12:30pm GMT
(Reuters) - The snail-like progress of European Union talks on fixing the bloc's debt troubles has begun to concern investors, raising the risk that the crisis will return with full force in the weeks ahead.EU leaders are holding a number of meetings to come up with a permanent plan, including a summit-to-prepare-for-a-summit on Friday, a finance ministers conclave to work on the detail next week, and a big, supposedly culminating summit on March 24/25.
The slow pace has left investors to try and price in an outcome that is by no means certain, exemplified by the gap in borrowing costs for Germany and debt-ridden outliers beginning to blow out again and the cost of insuring that debt rising.
Yield spreads between Greek and German bonds, for example, were at close to two-month highs earlier this week. Spreads have also widened sharply for Portugal, the candidate seen as most likely to follow Greece and Ireland in taking an EU/IMF bailout.
"There is an element of frustration in the markets that the European process takes so long," said John Stopford, head of fixed income at Investec Asset Management.
"The strategy seems to have been all along to do as little as possible and be reactive. We are inching towards some form of meaningful burden sharing. But it is ... at a piecemeal pace."
Since the euro zone's paymaster Germany signalled in January that a "comprehensive package" of new anti-crisis measures would be delivered at the late March summit, market expectations of a far-reaching deal have risen and stress on bonds initially eased.
Berlin appears ready to back an increase in the effective lending capacity of the bloc's rescue fund, the European Financial Stability Facility (EFSF), enabling it to lend the full 440 billion euros (377.9 billion pounds) it was originally intended to have.
But it is sceptical about changing the terms of an EU/IMF bailout that Ireland signed up to only a few months ago and a substantial extension of the EU loan maturities for Ireland and Greece also appears unlikely.
Perhaps most significantly, German Chancellor Angela Merkel opposes giving the EFSF powers to buy the bonds of stricken euro zone peripheral countries on the secondary market.
FALLING SHORT?
All this suggests the package due later this month may fail to address the chief concern of investors -- the risk of a Greek debt restructuring and of contagion to Portugal and beyond.
Nobody seems to doubt that record Portuguese borrowing costs with 10-year yields above 7.5 percent are unsustainable and will require Lisbon to seek outside help if they do not fall.
Treasury Secretary Carlos Pina told Reuters on Wednesday that record yields required "urgent measures at the European level to make the European Financial Stability Facility more flexible."
As of Thursday, Markit said the cost of insuring Greek government debt against default had widened to 1,033 basis points, with Ireland out at 585 bps and Portugal at 500.
If markets are disappointed by any EU deal and react forcefully, investors could begin betting on multiple debt defaults and a fracturing of the 12-year old currency zone.
"The market response will be driven around whether it is pain relief or cure," said David Shairp, global strategist for JPMorgan Asset Management.
The European Union often works at glacial pace, given the need to forge consensus among 27 member states, 17 of which are in the euro zone.
But markets are impatient. This week they clobbered Greece instantly after its sovereign ratings were downgraded by Moody's with barely a thought for what the EU might do to prop up Athens in the coming weeks.
Moody's said the chance of a Greek restructuring had risen.
As Mark Grant of U.S. firm Southwest Securities said in a note this week: "The European Union can manipulate yields and prices but in the longer game it is the investment community that will make the decisions."
What EU leaders may view as a finely crafted political compromise at the coming meetings could easily be seen by markets as a fudge that does not do the job.
PRICED IN ... OR NOT
Given this, it seems unlikely that when the EU eventually agrees a permanent crisis package that there will be a huge sigh of relief from investors and an accompanying settling down of the bond market.
And the longer the euro area's debt woes linger, the greater the chance that investors turn their attention to indebted countries outside the bloc, like the United States.
U.S. Treasury Secretary Timothy Geithner jetted to Germany for a day of meetings this week to express Washington's concerns about the looming summits in person. U.S. President Barack Obama raised the issue with Merkel in a phone conversation late last month.
"There is room for disappointment," said Klaus Wiener, head of research at Generali Investments in Cologne. "The hurdles for surprising markets positively are very high."
Nicolas Veron, senior fellow at the Brussels-based think tank Bruegel, sees two scenarios for market reaction.
One is that everything is being priced in -- which could explain why market stress has resurfaced -- and that the eventual decision will have no major impact.
His other scenario is that markets have not actually paid much attention yet.
"The market only focuses on one thing at a time. In recent weeks the focus has been on the situation in the Middle East and North Africa. A lot of investors consider the (EU) negotiating process ... opaque," he said.
That could open the door to a far more adverse reaction than is currently being seen.
"Authorities normally kick things down the road, and that can be good because time heals," billionaire investor George Soros told a breakfast meeting in Paris on Wednesday. "But now it is not good because time is working against us."
(Additional reporting by Paul Taylor in Paris, editing by Mike Peacock)
