We’ve been quiet on the Sovereign Risk front for some time, as it’s been well covered, but thought we’d share this brief update from BCA Research with those interested:
Greece: Short-Term Fix, But…
Greece’s rescue package will stave off the immediate risk of default, but does nothing to change the difficult structural backdrop.The €45 billion will come primarily from the European Union (€30 billion) with the remainder from the International Monetary Fund. The interest rate on the loan from the EU will be set at around 5%, a compromise between Germany and other EU members. This financing will avert a near term default for Greek government debt, allowing spreads to narrow sharply on the news. However, the broader debt sustainability issue has not disappeared: Over the longer-term, there are major hurdles for Greece that will make fiscal consolidation difficult. Policymakers are being forced to undertake fiscal restructuring before the economy recovers. Importantly, currency devaluation is not an option due to the common currency regime, implying that the country is highly likely to experience a prolonged deflationary adjustment. Bottom line: A reprieve in sovereign risk premia over the next couple of months could have a positive outsized impact on European assets, since this region is at the centre of fiscal consolidation concerns. However, headway in terms of the structural issues will be needed before a sustainable trend can get underway.
We are finding it more and more difficult to reach any conclusion outside of “Europe is Toast.” A deeply ingrained German fear of hyperinflation, coupled with forced austerity measures at the periphery all but guarantee a sustained economic deflation. Currency devaluation was the primary escape valve for reflating these economies in the past. What hope do they now have for escaping the powerful forces of debt deflation?
Consequently, it appears that we have the exact opposite dilemma in the states where our monetary policy is driven by The Son of Greenspan who will stop at nothing to hyper-inflate us out of the Great Depression Part II. While our transition to double digit interest rates will take longer than most market watchers expect as a result of ongoing deleveraging and credit pressures, it is simply a question of timing. At home, we’re reviewing two playbooks – Deflation Now and Inflation Later. Our European peers only need one playbook.