Tuesday, March 1, 2011

EU Ministers Move to Calm Bond Market

Tensions in Europe’s battered bond markets are easing a bit following a statement by European Union finance ministers (see below) that is fueling speculation of an imminent bailout for Ireland.

Let’s take a look: The interest rate on Ireland’s 10-year government bond, which moves inversely to its price, has fallen to 8.50% from 9.25% late on Thursday. Were it to borrow money from the capital markets for 10 years, the premium that Ireland would have to pay over safer Germany’s borrowing rate is 6 percentage points compared with 6.81 percentage points on Thursday. In the credit-default swaps market, the cost to insure $10 million of Ireland’s government bonds against default for five years has sunk to $535,000 from $595,000.

Portugal, which is investors’ biggest worry after Ireland and Greece, is benefiting, too. The country’s two-year bond yield has fallen to 4.30% from 5.37% Thursday –- a big move. The interest rate on Portugal’s 10-year bonds is just under 7% compared with 7.38% on Thursday. Greece’s bond market is improving, too, though the country is -– along with Ireland -– pretty much locked out of the long-term financing market. Spain’s bond market is up a bit, which could ease concerns that Ireland and Portugal’s problems will infect larger European economies like this country and Italy.

The euro is also jumping higher, trading at $1.3740, after falling below $1.36 in Asian trading. But we’re down significantly from the nearly $1.43 level we reached after the Federal Reserve’s revived “quantitative easing” program boosted all risky investments (like the euro) -– a huge six cent fall.

It still seems unlikely that we’re going to get some kind of EU bailout for Ireland in coming days, since Ireland isn’t facing an imminent liquidity crisis. It has enough cash to pay expenses until the middle of next year and has no bonds coming due for repayment.

But it appears that European Union leaders have finally realized they need to calm the bond markets of the region’s weaker economies before they rattle Spain and Italy.

For two weeks now, the bond markets of Ireland, Portugal, Spain and Italy -– the 16-nation euro-zone’s weakest economies -– have suffered partly due to speculation that an effort by European leaders to craft a permanent bailout mechanism for struggling euro members will end up requiring bond investors to share in the pain. Now, “burden-sharing” is a sensible idea. As German chancellor Angela Merkel has said, European taxpayers shouldn’t foot the entire bill for bailouts, as they did with Greece earlier this year.

But while European officials have said any such “burden-sharing” would only apply to new bonds issued after 2013, their efforts have freaked out the market. For one thing, it has potentially encouraged any speculative players like hedge funds to bet heavily against, say, Ireland. Now, the risk is a full-blown sequel to this spring’s Greek-focused euro-zone debt crisis.

Ironically, European leaders are destabilizing Europe’s markets by trying to create a permanent system for stabilizing it. Irish Finance Minister Brian Lenihan has blamed Ireland’s jumping yields in his country’s bond market on the Franco-German proposal on burden-sharing, and he’s partly correct. Mr. Lenihan said Thursday that Ireland would pursue “diplomatic” channels to try to clarify the situation for bond holders. Well, here’s the result (see EU leaders’ statement below.) So far, Europe’s bond markets are rallying -– but it’s hard to tell whether the improved clarity on Europe’s future bailout mechanism is driving the moves, or just fears of an imminent bailout announcement.

Here’s the statement by EU leaders …

Terms of Reference by the Finance Ministers of France, Germany, Italy, Spain and the UK

12 November

At its meeting on 29 October 2010, the European Council discussed the future arrangements for ensuring economic and financial stability in the European Union.

Whatever the debate within the euro area about the future permanent crisis resolution mechanism, and the potential for private-sector involvement in that mechanism, we are clear that this does not apply to any outstanding debt and any programme under current instruments. Any new mechanism would only come into effect after mid-2013 with no impact whatsoever on the current arrangements.

The EFSF is already established and its activation does not require private sector involvement. We note that the role of the private sector in the future mechanism could include a range of different possibilities, such as a voluntary commitment of institutional investors to maintain exposures, a commitment of private lenders to roll-over existing debt or the inclusion of collective action clauses in future bond emissions of euro area Member States.

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