Euro Crisis: No Rest for the Indebted

By Neil Shah

European officials are trying to convince Ireland to take financial aid to prevent its problems from infecting other, larger indebted countries like Spain and Italy. So far, it’s not working that well.

After five straight days of speculation about an imminent Irish rescue by the E.U. and International Monetary Fund, Ireland, European finance ministers and the European Central Bank are still locked in a stand-off. European ministers are talking to Dublin about a potential aid package for the country’s rickety banks, probably totaling some €50 billion ($67.45 billion), but so far, Irish officials continue to say they have not requested any aid.

So, how has Europe’s bond market responded? Well, some of the recent turbulence has halted, but things aren’t really improving, which means debt-laden countries like Spain and Italy are still facing elevated interest rates to refinance their debts.

Let’s start with Ireland itself, which has said it won’t borrow from the market until next year to avoid paying high costs. The interest rate on Ireland’s benchmark 10-year government bond, which moves inversely to its price, is 8.56% on Wednesday compared with 8.58% on Tuesday. After falling Friday and Monday, Irish borrowing costs are again rising. The reason: Dublin has agreed to have European Central Bank, IMF and European Union officials visit to take a look at the country’s banks, starting Thursday. But markets still aren’t sure this will mean a new Irish bank bailout, even though Ireland-based banks are more dangerously reliant on emergency ECB funds than institutions in Greece, Portugal or Spain.

Looking elsewhere, the bond markets of Portugal, Spain and Italy haven’t gotten rid of their Ireland-related infection.

On Wednesday, Lisbon sold €750 million of 12-month Treasury bills, but paid investors a painfully-high interest rate of 4.8% compared with 3.3% earlier this month. Interest rates don’t usually jump that much in, like, two weeks.

Were it to borrow for 10 years, Portugal, a small European economy with weak growth prospects, would probably have to pay an interest rate of 6.87%, based on market prices, compared with 5.86% in early September.

Spain, Europe’s fourth-biggest economy, would have to pay 4.62% to borrow for 10 years compared with 4.06% two months ago.? It will be in the market selling long-term debt on Thursday. And let’s not forget Europe’s No. 3, Italy: It would have to pay 4.15% compared with 3.76%. (Greece’s borrowing costs are jumping higher too, but it’s locked out of the capital markets and will be mostly using bailout money for the next few years.)

Many euro club members bear heavy debt loads, which is why it’s important for them to keep their interest costs low. Higher interest payments just put more debt on their pile. The worry among European officials is that a sudden spike in borrowing costs will make these countries’ debt burdens unsustainable.

Meanwhile, Spain has suffered a banking and property crunch much like Ireland’s and has probably been less transparent about the value of the property loans in its financial system. That is leading some investors like Cambiz Alikhani at London-based asset manager Iveagh Ltd. to worry that Ireland is a side-show and that a potential Spanish crisis is the elephant in the room.

A third act to Europe’s debt saga, following Greece and Ireland, would further test the durability of what has arguably been Europe’s greatest political success over the last half-century, the euro itself. Since the euro-dollar exchange rate is the most important in the world – the euro is the second-most traded currency – a currency collapse could have catastrophic consequences for markets.

On Wednesday, the euro is continuing to struggle amid Europe’s debt woes, having fallen to $1.35 from nearly $1.43 a few weeks ago – a 6% drop – though some of the drop is investors unwinding bets against the dollar in light of rising U.S. interest rates. In a comforting sign, the euro remains above the $1.18 level we hit during Greece’s spring crisis, but everyone’s now wondering whether it has further to fall if Europe’s latest sovereign-debt fire isn’t put out.

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Investors Unsure When Ireland’s Crisis Will Peak

By Neil Shah

Investors are betting that Ireland’s debt crisis is about to climax, but nobody seems to know what that climax is going to be.

Ireland’s government bonds soared on Friday as expectations grew that the small European country might give in to pressure from the European Central Bank and some national governments to take emergency aid to prevent its problems from infecting other euro members like Portugal and Spain. On Monday, the “Ireland-is-getting-a-bailout” rally continued, with financial stocks leaping higher and the cost to insure Irish bank bonds – even risky “subordinated’ bonds – dropping massively.

A day later, the rally has halted. The yield on Ireland’s 10-year government bond, which moves inversely to its price, is 8.13% compared with 8.10% on Monday. Ireland’s two-year bond yield, meanwhile, is 6%, a tad higher than Monday’s 5.93%. The cost to insure Ireland’s government bonds against default using derivatives called credit-default swaps is also higher: As of 11:45 a.m. in London, it costs $515,000 a year to insure $10 million of Irish government debt for five years compared with $504,000 on Monday, according to data provider Markit.

Europe’s broader financial markets are also in a holding position, waiting for news from a key meeting of euro-area finance ministers in Brussels Tuesday evening. Ireland’s banking problems, and possibly some sort of banking-related European rescue, will be discussed. (There’s also a meeting of European Union finance ministers on Wednesday.) The euro is trading at $1.3590, a little higher than its $1.3585 level on Monday, but it’s flat against the Japanese yen, British pound and Swiss franc. Spain and Greece sold Treasury bills Tuesday without a fuss, though they paid steeply higher interest rates to borrow.

Irish government ministers continue to claim that the country has not requested a European Union or International Monetary Fund bailout. However, Irish Prime Minister Brian Cowen’s latest comments do highlight the fact that Irish officials have been talking on some level with European officials about the latest euro-zone turbulence and what can be done about it. According to Chris Turner, an analyst at Dutch bank ING, the market is expecting (read: hoping for) a €60 billion to €80 billion bailout effort. Irish media reports and some analysts say Irish finance officials may be trying to find some way to get the E.U. to effectively re-bail out Irish banks, which are the source of the country’s debt crisis. While Ireland’s government has enough cash to make it through to the middle of next year, its banks are surviving only because of the generosity of the European Central Bank, along with Ireland’s own central bank. The problem is that the E.U.’s emergency-rescue fund, designed amid Greece’s debt crisis earlier this year, funnels cash to governments, not national banks. Irish officials, meanwhile, may be open to some aid, but are desperate to avoid any semblance of a sovereign default.

Markets, which don’t know what to think, are largely staying put. Sure, the euro-zone’s latest woes are weighing on the euro. That’s why it’s down from nearly $1.43 a few weeks ago. But the currency’s decline could equally be about dollar-buying, rather than euro-selling. Interest rates on U.S. Treasury bonds have recently jumped higher after falling in the wake of the Federal Reserve’s $600 billion money-printing revival. Rising rates make U.S. dollar-denominated fixed-income investments more attractive.

And even the recent drop in Ireland’s credit-insurance costs should be viewed with some skepticism. Gavan Nolan, analyst at data provider Markit, noted on Monday that the drop was largely due to “short-covering.” In other words, investors with bearish bets against Ireland have been extracting profits by closing out their trades, which effectively involves selling insurance to other parties, lowering its price. That is different from positively betting that Ireland’s creditworthiness has improved.

Investors are betting that Ireland’s debt crisis is about to climax, but nobody seems to know what that climax is going to be.

Ireland’s government bonds soared on Friday as expectations grew that the small European country might give in to pressure from the European Central Bank and some national governments to take emergency aid to prevent its problems from infecting other euro members like Portugal and Spain. On Monday, the “Ireland-is-getting-a-bailout” rally continued, with financial stocks leaping higher and the cost to insure Irish bank bonds – even risky “subordinated’ bonds – dropping massively.

A day later, the rally has halted. The yield on Ireland’s 10-year government bond, which moves inversely to its price, is 8.13% compared with 8.10% on Tuesday. Ireland’s two-year bond yield, meanwhile, is 6%, a tad higher than Monday’s 5.93%. The cost to insure Ireland’s government bonds against default using derivatives called credit-default swaps is also higher: As of 11:45 a.m. in London, it costs $515,000 a year to insure $10 million of Irish government debt for five years compared with $504,000 on Monday, according to data provider Markit.

Europe’s broader financial markets are also in a holding position, waiting for news from a key meeting of euro-area finance ministers in Brussels Tuesday evening. Ireland’s banking problems, and possibly some sort of banking-related European rescue, will be discussed. (There’s also a meeting of European Union finance ministers on Wednesday.) The euro is trading at $1.3590, a little higher than its $1.3585 level on Monday, but it’s flat against the Japanese yen, British pound and Swiss franc. Spain and Greece sold Treasury bills Tuesday without a fuss, though they paid steeply higher interest rates to borrow.

Irish government ministers continue to claim that the country has not requested a European Union or International Monetary Fund bailout. However, Irish Prime Minister Brian Cowen’s latest comments do highlight the fact that Irish officials have been talking on some level with European officials about the latest euro-zone turbulence and what can be done about it. According to Chris Turner, an analyst at Dutch bank ING, the market is expecting (read: hoping for) a EUR60 billion to EUR80 billion bailout effort. Irish media reports and some analysts say Irish finance officials may be trying to find some way to get the E.U. to effectively re-bail out Irish banks, which are the source of the country’s debt crisis. While Ireland’s government has enough cash to make through to the middle of next year, its banks are surviving only because of the generosity of the European Central Bank, along with Ireland’s own central bank. The problem is that the E.U.’s emergency-rescue fund, designed amid Greece’s debt crisis earlier this year, funnels cash to governments, not national banks. Irish officials, meanwhile, may be open to some aid, but are desperate to avoid any semblance of a sovereign default.

Markets, which don’t know what to think, are largely staying put. Sure, the euro-zone’s latest woes are weighing on the euro. That’s why it’s down from nearly $1.43 a few weeks ago. But the currency’s decline could equally be about dollar-buying, rather than euro-selling. Interest rates on U.S. Treasury bonds have recently jumped higher after falling in the wake of the Federal Reserve’s $600 billion money-printing revival. Rising rates make U.S. dollar-denominated fixed-income investments more attractive.

And even the recent drop in Ireland’s credit-insurance costs should be viewed with some skepticism. Gavan Nolan, analyst at data provider Markit, noted on Monday that the drop was largely due to “short-covering.” In other words, investors with bearish bets against Ireland have been extracting profits by closing out their trades, which effectively involves selling insurance to other parties, lowering its price. That is different from positively betting that Ireland’s creditworthiness has improved.

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Euro Fiscal Crisis, Possible China Rate Hike Roil Markets

By Dave Kansas

European stock markets are following their Asian cousins lower this morning amid rising concerns about potential fiscal and monetary tightening in China along with the roiling sovereign debt issues along the edge of the euro zone.

China’s reported strong growth earlier this week, but also high inflation figures. Thus far, China has been chary about tapping on the brakes too hard, but with inflation at 5%, they may be forced to take stronger action which could curtail growth. Shanghai shares plunged 5% and other Asian markets fell 1% to 2%.

European leaders in Seoul for the G20 meeting are watching the euro-zone peripheral fiscal crisis flare anew, with Ireland firmly in the crosshairs and Portugal not far behind. Market indicators, specifically spiking Irish and Portuguese bond yields, indicate investors believe a bailout of some stripe will be required for both countries.

The two countries, along with Greece, represent about 5% of the 16-member euro-zone economy. But Spain and Italy loom as two larger possible problem spots. Bond yields for Spain and Italy are nowhere near their smaller, troubled neighbors, but fears are rising that the fiscal crisis could spread.

“The concern is that if Ireland is unable to pass a new budget, and either it or Portugal feels it necessary to consider tapping the Euro Financial Stability Facility bailout fund, markets could send [credit insurance costs higher]…and possibly start a contagion effect across Europe,” Michael Hewson at CMC Markets told Dow Jones.

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Euro-Zone Crisis Viewer’s Guide

By Neil Shah

Europe’s debt problems are on everyone’s lips again thanks to soaring bond yields in weaker euro-bloc countries like Ireland. Here’s a crib sheet on what to watch this week.

* The indefatigable euro. The value of Europe’s common currency has somehow shot higher despite rising tensions in debt-addled Ireland, Portugal and Greece. Last week, the euro jumped to around $1.43–a nine-month high–after the U.S. Federal Reserve goosed the financial markets by announcing $600 billion in additional monetary stimulus. With the Fed’s long-anticipated decision now in the rear-view mirror, analysts are warning that attention could return to Europe’s sovereign-debt problems, hurting the euro’s exchange rate with the dollar and pound. This may already have started: A glowing U.S. jobs report on Friday muffled the euro, and the currency is struggling again Monday on a wave of euro-zone debt concerns, dropping 0.7% to $1.3932. Traders seem to be looking downwards: Even though we got a rare piece of good news from Greece -– Prime Minister George Papandreou didn’t end up calling snap elections like some feared –- the euro isn’t getting much help. (Greece’s stock market is, though – it’s up 2.5%.)

*Irish and Portuguese bond yields. These can only go up these days it seems. If Ireland tried to borrow money from investors for 10 years, it would probably have to pay an interest rate of 7.83%, a record 5.43 percentage-point premium over Germany’s borrowing rate. Unlike Greece earlier this year, Ireland has enough cash in its coffers to avoid going to investors for a while, and it also doesn’t have a major bond repayment due until November of next year. But this kind of 10-year borrowing rate is unsustainable, fueling fears the country will need to use the European Union’s emergency-rescue mechanism. “The key to success or failure is … to control funding costs,” says Arnaud Mares, a former credit rater and now an analyst at Morgan Stanley, in a report Monday. “If the Greek or Irish government had to pay current market yields on a sustained basis, it would be less plausible that debt stabilization would occur.” At 8 p.m. in Dublin Monday, Irish Finance Minister Brian Lenihan and top European economics official Olli Rehn -– who’s visiting there to help Ireland hammer out deficit-cutting plans –- will try to calm the market with a press conference.

* Politics, politics, politics. Investors are paying unusually close attention to political wrangling in Greece, Ireland and Portugal since this can determine whether countries stick to deficit-cutting plans. Greece’s ruling Socialist party survived a key test of its popularity in local elections Sunday, but one thing spooking the market on Monday is news from Ireland: A member of Ireland’s Green party, the junior partner in the country’s ruling coalition government, is saying Ireland shouldn’t cut public-sector pensions in its upcoming Dec. 7 budget for next year. Most observers expect Ireland’s political parties to come together to pass the budget, but jostling before the date is likely to keep investors on edge. Irish Prime Minister Brian Cowen’s coalition government has only a razor-thin three-seat majority in Parliament. A big political foul-up could lead to new elections if the budget doesn’t pass.

* Three more things. It’s also worth watching Portugal’s bond sale on Wednesday for signs of trouble.? A failed bond auction or a major jump in borrowing costs could rattle investors, though China just promised to help the indebted country, possibly with purchases of government bonds. China has made similar cooing noises to Greece and Spain. Later Monday, we’re going to find out whether the European Central Bank had to intervene in Europe’s bond markets last week by buying bonds to push yields down. The ECB hasn’t done that for several weeks now, so fresh purchases, even if they’re very small, would be another bad sign –- though it’s also possible that bond yields are jumping because the ECB is not buying bonds. Last but not least, we’ve got gross domestic product figures coming out for the euro-zone on Friday, with Germany, of course, expected to lead the pack and Spain expected to dawdle. Members of the euro zone are slashing their budgets to cut their huge deficits, but there’s only so much that ripping up budgets can do. At some point, to get your debt burden under control, you need good old growth, which brings in tax revenue.

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