10 May 2012

Flash Update

The Eurozone Crisis

The focus now is on Greece leaving the Euro and the subsequent impact on Spain. Despite the threats of tearing up the bailout conditions by Alexis Tsipras, he is not able to form any government due to a lack of support from other parties. It seems likely that new elections will be held in June if no government can be formed. Greece's impact is limited due to the debt restructuring, which left the bulk of its debt in the hands of the ECB. The concern is more on Spain - if there is a massive flight to safety. Spanish bond yields may have risen in recent days (Figure 1), but it is nowhere near panic mode.

Image courtesy of Bloomberg

Figure 1: Spanish Bond Yields

It is also important to note that the IMF1 is softening its stance on austerity. Greece's bailout terms is likely to change to alleviate the common man's hardship and to make it more palatable to others like Spain (when necessary). This is the reason yields have to go up from their lows, with spreads increasing with Germany, since deficit will persist longer than initially planned and fiscal targets will be missed.

Again, we look to the other sectors of the bond market for clues. Emerging market and high yield debt are doing very well with no sign of risk aversion. If there were any indication of a massive flight to safety, these markets should be affected also. If markets were anticipating a flight to safety, investors would be selling before Greece leaves the Euro, not when it actually happens. Equities are just more volatile, that's all.

As for the US, the numbers are actually quite decent; and market signals confirm this. That is also why we are not inclined to turn bearish or cautious yet. The signs are not there despite negative headlines and the return of volatility.

1. IMF shows new flexibility on fiscal austerity. 7 May 2012. Bloomberg News

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