"As forecasts for peripheral macro data continue to deteriorate and core to
strengthen modestly, there is little real comfort available from the European
situation aside from the 800lb gorilla that all headlines are focused on today.
Credit Suisse describes it as "a case of the outlook being less bad than
expected, rather that it being better" and notes that post the Greek
situation, despite the ongoing rally in the ever-thinning sovereign bond market,
that risk premia (that were dangerously forgotten for the first decade of the
Euro) will remain at elevated levels. CS sees three scenarios beyond
Greece with even the best-case leaving questions of sustainability,
trust, and continued negotiations yet the market's willingness to follow along
the path of inevitably ruinous policies seems writ large with today's credit,
equity, and FX strength.
Economic growth forecasts revision - core up and periphery down
Looking beyond Greece we think the key factor driving spreads and yields will be the growth prospects of European countries. In the pre-crisis days low growth implied low yields. This may continue to be the case for core markets, but for non-core markets a lack of growth means that the debt burden, and hence the risk premium, will remain high. In pre euro days we see a positive correlation between yield levels and growth. This is less evident post euro and the most recent development is that yields have been rising as the growth outlook has been declining.
We think this marks a significant change in market perception of sovereign risk. For the first ten years of the euro the market has effectively priced out the risk premium for European sovereigns. On the basis that Greece is resolved in a relatively orderly fashion, we think markets will continue to price in this risk premium, and although peripheral spreads may experience some tightening versus core, we think the risk premium remains at elevated levels.
(Trying to) look beyond Greece
As we monitor developments, and look to evaluate the outlook for the European government debt markets post the 20 March, we therefore see broadly three general scenarios:
Economic growth forecasts revision - core up and periphery down
Looking beyond Greece we think the key factor driving spreads and yields will be the growth prospects of European countries. In the pre-crisis days low growth implied low yields. This may continue to be the case for core markets, but for non-core markets a lack of growth means that the debt burden, and hence the risk premium, will remain high. In pre euro days we see a positive correlation between yield levels and growth. This is less evident post euro and the most recent development is that yields have been rising as the growth outlook has been declining.
We think this marks a significant change in market perception of sovereign risk. For the first ten years of the euro the market has effectively priced out the risk premium for European sovereigns. On the basis that Greece is resolved in a relatively orderly fashion, we think markets will continue to price in this risk premium, and although peripheral spreads may experience some tightening versus core, we think the risk premium remains at elevated levels.
(Trying to) look beyond Greece
As we monitor developments, and look to evaluate the outlook for the European government debt markets post the 20 March, we therefore see broadly three general scenarios:
- Debt restructuring completed in (relatively) orderly manner and vast maturity of Greek debt has been restructured, second bailout in place.
- Partial restructuring with ongoing debate – continuation of current situation.
- Failure-to-pay or debt moratorium on 20 March bond..."
