Euro-Zone Contagion Spreads

Greece’s credit rating was cut 3 steps to junk status by Standard and Poor’s (S&P), the first time a Euro-Zone member has lost its investment grade since the currency’s 1999 debut.  The Euro weakened and stock markets throughout the region tumbled.

Greece was lowered to BB+ from BBB+ by S&P, which also warned that bondholders could recover as little as 30% of their initial investment if the country restructures its debt.  The move, which puts Greek debt on par with bonds issued by Azerbaijan and Egypt, came minutes after the rating agency reduced Portugal by two steps to A- from A+.

Yesterday, the spread on Greek 10-year bonds over German counterparts widened to 6.75%, the highest since at least 1998, as investors increased bets that Greece will restructure its debt.  The Portuguese spread jumped 0.59% to 2.77% and the Spanish spread rose to 1.13%.

The spread between Portugese and benchmark German 10-year bonds rose about 0.5% Tuesday to reach its highest point since the creation of the Euro.  The higher spread demonstrates less confidence in Portugal, whose bonds had an interest rate of 5.86% higher than German bonds on Tuesday.

Germany, where the bail-out is unpopular with voters, has been slow in authorizing the release of funds.  Its delay has furthered market panic and driven Greek 2-year bond yields to as high as 21%.

Greek 5-year yields hit 10.6%, higher than many emerging market economies, including Ecuador at 10.5% and Ukraine at 7.1%.

The carnage continued into this morning's early trading.  The yield on 10-year Greek bonds surged to 11.24% early Wednesday from 9.68% on Tuesday.  The yield is the highest for the 10-year since the introduction of the Euro in 2002.  The 2-year bonds were trading with yields approaching 20%.

Today's jump in the yield on the Greek bond has led to an enormous spread of 8.22% compared with German bond yields.  The yield on the German 10-year bond, considered the European benchmark, slipped to 3.02% early Wednesday, suggesting a flight to safety.

Greece needs to raise AT LEAST 9 billion Euros by May 19, but, given the current market yields, will have no chance of attracting institutional investors.

The marketplace has now spoken.  Greece will need a major restructuring and existing bondholders will receive a haircut of at least 50% and possibly larger.  The bail-out package, just activated, will be insufficient to cure the disease.  While Germany continues to say the right things, such as indicating that Greece must not be allowed to fail,  it has yet to act.  Given the growing unpopularity in Germany of bailing out Greece, any aid package remains to be seen.

The only question now is how far the contagion will spread.  Will Portugal be next to fall in the abyss?  How many more countries will be taken down?  No need to worry.  Marko's Take is on the job.

Marko's Take

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