European Debt Markets Look Past Moody's, but No Closure in Greece

Currency in Crisis

Moody's cut the ratings of 6 euro zone sovereigns late yesterday and gave negative outlooks to the UK, France an Austria.  The euro itself fell a little more than half a cent before stabilizing in late Asia, but the debt markets have taken it in stride. 

There were several sovereign auctions today and the supply was easily absorbed.  Spain's bill auction saw slightly lower yields.  Italy's bond auction went off without a hitch.  The borrowing costs are the lowest since March 2011.  This follows yesterday's bill auction that produced the lowest yields since last June.   Given the advance in European equities (mostly 0.2%-0.5%) the slightly heavier tone to the core bonds cannot really be attributed to Moody's. 

Greece raised more than it initially anticipated in today's bill auction.  It faces a bill redemption late this week.   Greek bonds remain under pressure as the controversial Athens vote Sunday failed to deliver closure. 

Three issues are pressing today, ahead of the Eurogroup of finance ministers meeting tomorrow.  First, Greece officials need to identify 325 mln euro in savings that are needed to replace a piece of pension reform that  the political leaders balked over. 

Second, the creditors are looking for greater assurances that the commitments will be implemented after the election.  At first this seemed a bit much, but look closely at what the New Democracy head Samaras (odds on favorite to become next prime minister) told the Greek parliament Sunday:

"I want to avoid the jump off the cliff today, to buy time, to restore normality and to go to the elections tomorrow.  This is why I ask you to vote in favor of the new loan agreement today to have the ability tomorrow to negotiate and to change the current policy, which has been forced upon us." 

Surely an reasonable reading of those comments raise questions about commitment. 

Third, Finland is pressing ahead with its demand for collateral in exchange for supporting the second aid package for Greece.  This is potentially disruptive because other countries may object to Finland's special treatment and may seek collateral themselves.  Recall that last year Finland struck a deal to get extra assurances in exchange for funding ESM up front. 

Lastly, look at the sums involved.  The first aid package was for 110 bln euros.  The second package appears to be for about 130 bln euros.  The private sector debt forgiveness may be worth 100 bln euros.  This is 340 bln euros.  Greece's entire debt was around 350 bn euros at the start of the crisis.  

The point we cannot emphasize sufficiently is that Greece is not being bailed out.  Workers are losing their jobs, wages and pensions.   Taxes are rising.  The economy is contracting.  GDP was 7% smaller in Q4 2011 than in Q4 2010.  For the entire year, the economy contracted 6.8%.  The government has assumed a 6% contraction in 2011 for this year's budget forecasts.  

The fact that the VAT proceeds fell 18.7% in January is unlikely to reflect tax evasions as much a dramatic compression of demand. 

If Greece is not being bailed out, where are the funds going?  The vast majority of the aid money is going to service Greece's debt.