The Euro continues to trend lower against the Dollar as the recent turmoil in Greece’s government bond markets has started to spread to Portugal and Spain too.  Events are starting to spiral out of control, evidenced by 10-year Greek bond yields rising from below 6% to more than 7% over the past few weeks (inflicting losses on the buyers of Greece’s €8 bln 6.2% 2015 bond which was issued on 25th Jan 2010).

Eight billion euros is only the first instalment on the €53 bln which Greece needs to raise in 2010 and it is this impending refinancing need which will bring matters to a head sooner rather then later.  Greece is now in the market’s spotlight and is really in trouble because this particular bond market storm is not going to simply blow itself out and go away.

The panic in Greece’s bond market is going to have to get a whole lot worse and this will eventually force the rest of the Euro-zone to act.  The markets don’t believe that the Greek government will be able to impose austerity measures on the Greek public (public demonstrations and strikes have already started).  ECB President Trichet has been quoted as saying ”We expect and we are confident that the Greek government will take all the decisions that will permit them to reach their goal”.  What else can he say?  If he told the truth and said they were stuck like pigs in a poke and the squealing would have to get a whole lot louder before they get bailed out, then Greece’s bond market collapse would intensify and yields would rise even more rapidly.

The endgame is fast approaching and it will not include the IMF lending money.  The bigger and more stable members of the Euro cannot allow Greece to be rescued by the IMF and thereby show the whole world that Euro-land can’t manage its own internal affairs.  Whatever tax-raising promises get made by the Greek government are irrelevant (as only time will tell whether they can actually impose the promised tax rises on the Greek public) as Greece does not have the luxury of time on its side.  

The end of this crisis will be signalled by a large amount of money being loaned to Greece by any or all of the following : Germany, France and the ECB.  Watch out for a classic euro-zone “enhanced credit support” fudge whereby the ECB suddenly decides to embark upon Quantitative Easing which involves the purchase of large quantities of euro-zone members’ government bonds.  The EU itself cannot extend a long-term loan because it also represents non-eurozone members.

Markets are going to become even more disorderly before this panic is over but the bigger picture is that this is a panic in the PIIGS’ government bond markets and, whilst it may impact other markets in the short-term, the resolution of the crisis will provide a buying opportunity across multiple asset classes.  The Euro will keep trending lower against the Dollar (and Sterling to a lesser extent) until the crisis is resolved because the resolution may involve the ECB printing a few hundred billion euros.  The ECB will then have joined the other major central banks in the Race to the Bottom and, as usual, the ECB will once again have proved itself to be the slowest to act.

The head of the ECB Jean-Claude Trichet was most insistent during his press conference after the latest ECB meeting that their proposed purchases of €60 bln of “covered bonds” (mostly mortgage-backed securities issued mainly by German banks) did not mean that the ECB was commencing quantitative easing.  His exact words during the Q&A session of the press conference were “we are not at all embarking on Quantitative Easing”. 

Instead the €60 bln covered bond purchase plan was presented as providing “enhanced credit support” to the covered bond market which will help to improve the spreads, depth & liquidity of this particular market, seen by the ECB to be in particular trouble at the moment.

The Bundesbank has clearly dug its heels in over the ECB going down the road of QE and has compromised by agreeing to throw €60 bln instead at the covered bond market.  Good to see the old City adage “If there is a problem then throw money at it until it goes away” has been taken on board by the burghers of Frankfurt.

Meanwhile the Bank of England has taken that particular City adage to heart by expanding its QE program from £75 bln to £125 bln.  And if that does not do the trick then expect the BoE to throw even more money at the problem…there is no shortage of money to spend when the BoE can just print it (even if they describe this printing as “electronically crediting the accounts of those instituitions” which sell securities to the Asset Purchase Facility).  The BoE is aiming to ease the flow of credit throughout the economy by purchasing gilts (mostly).  It hopes the selling institutions will re-invest the proceeds elsewhere, thereby boosting asset prices & tightening credit spreads.  It also hopes that some of this money will leak out into the wider economy and end up as spending on goods & services.  By restricting their buying to gilts, the BoE will be unlikely to lose money as they are financing their purchases at near-zero rates of interest and will likely hold the gilts to maturity.  By spending a big percentage of the Government’s borrowing requirement, the BoE is also hoping its purchases will help to avoid private borrowers being “crowded out” by the deluge of gilts being issued.  Expect the BoE to spend much, much more than £125 bln before its Quantitative Easing program comes to an end.  They truly are going to throw a great deal of money at this problem until it goes away.