Monday, 7 June 2010

Markets also say the Euro's time is up

Following on from the Telegraph's 25 economists I had a look at the Euro bond and FX markets this morning. First the 10 year bond rates. (For those who may be puzzled why there is always such a rate. In almost all cases it does not refer an actual bond but to the 10 year point on the sovereign yield curve for that country which is an interpolation of yields on actual bonds.)

Sovereign 10 year bond yields
Germany 2.57%
Greece 8.60%
Portugal 5.30%
Spain 4.58%
Italy 4.26%

The Greek German spread of over 6% is back up to what it was before the EU/IMF bail out, a sign the markets have little faith in the bailout working. The Portuguese spread of 2.7% also indicates severe misgivings about Portugal and also Spain at a 2% spread. These three governments will have to pay more and more of their national income to service their debt as they have to refinance maturing loans on the markets. This implies more cuts in their public sector and a higher probability of civil unrest. The only thing that will save the UK from a similar fate is the much longer average maturity of UK debt, around 14 years, so we don't have to come back to the market nearly as often as the PIGS, average bond maturity around 4 years. The reason for that discrepancy is based on the unwillingness of the market to lend long to the PIGS, say 25 years, because of the history these countries have of defaulting on their debt!

Turning now to the Forex market, the Euro is now trading at 1.194 against the dollar in very volatile trading. It is expected to fall further possibly as low as 1.15. This impacts on any asset denominated in Euros e.g. sovereign bonds but also equities. It takes a huge interest rate differential to compensate for the likely FX losses with the Euro falling as fast as it is currently.

The big gainers from this scenario are the Germans with their huge export industry which is becoming more and more competitive with every fall in the Euro. Also, the low German interest rates transmit to commercial rates meaning German industry can raise investment funds at a cheap rate and make themselves even more competitive and their workers better off. The Greek people are the ones whose living standards are being hit and are paying for this German prosperity. German surplus funds should be recycled in part to Greece but this is now political suicide for Dr Frau Merkel. A politicians lot is not a happy one as in G&S!

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