On Sunday, Greece reached a deal with other euro-zone countries and the International Monetary Fund (IMF) for a huge bailout, while the Greek prime minister exhorted (begged?) his recalcitrant public workers and retirees to bear the “harsh sacrifices” called for in the bailout agreement. The total cost to the EU and IMF is expected to surpass 100 billion euros ($133 billion) over three years. We’ll have to see how bad the protests will be, but even under the best of circumstances and with a willing public, it will take until 2014 to get the Greek debt under the EU limit of 3% of GDP, down from last year’s 13.6%.
Last week, Greek two-year debt yields soared to 23% before closing the week at 12.74%, the highest yield on any short-term government debt in the world, surpassing Venezuela’s 11%. The Greek bond market seems to be pricing in a high probability of a default within two years. Not surprisingly, on Tuesday, Standard & Poor’s downgraded Greece’s sovereign debt three notches, to BB+ (“junk” status).
The “Greek disease” is now spreading to other euro-nations. For example, two-year yields rose by over 0.75% last week in Ireland and Portugal, while Spain‘s rates rose 0.25%. Portugal’s 5-year government bond yields rose to 3.49% last week, after Standard & Poor’s lowered Portugal’s long-term sovereign issue credit ratings to A- from A+. Then, on Wednesday, S&P downgraded Spain one notch to AA, from AA+ Spain’s economy continues to suffer from the implosion of its massive housing bubble and 20% unemployment, the highest rate in Europe. Spain’s government said that it intends to cut its budget deficit to 3% of GDP by 2013, but it’s hard to see how they could accomplish that Herculean feat so fast.
Low Rates are Vital to U.S. Debt Financing
Fortunately, the sovereign debt crisis in Europe has not spread to the U.S. yet, even though the U.S. federal budget deficit, as a percentage of GDP, is almost as high as Greece’s. I will continue to watch our Treasury auctions very carefully to see if the U.S. is borrowing more than the world wants to buy. For the time being, however, it appears that the U.S. is benefiting from foreign capital flight from euro-zone debt.
Last Thursday, Bloomberg reported that the media’s reigning “Dr. Doom,” Professor Nouriel Roubini, said that sovereign debt from the U.S. to Japan and Greece will lead to higher inflation or government defaults. During a Wednesday panel discussion on financial markets at the Milken Institute Global Conference in Beverly Hills, Roubini said “The bond vigilantes are walking out on Greece, Spain, Portugal, the U.K. and Iceland,” but he added “Unfortunately in the U.S., the bond-market vigilantes are not walking out.” Roubini’s pessimistic outlook may explain why gold hit a five-month high last week.
The Federal Reserve did their part to keep U.S. interest rates low by saying last Tuesday that the Fed “will maintain the target range for the federal funds rate at 0% to 0.25% … for an extended period.” Another reason why the Fed will not likely raise key interest rates this year is that on Thursday, President Obama nominated three more “doves” to the Fed. As a result, the Fed is expected to increasingly target unemployment rather than inflation, while becoming a more politicized arm of White House policy.
Other Central Bank Actions Last Week
There was one rate cut, one rate increase and one “no change” last week, for a net “no change” in rates:
- Brazil‘s central bank raised its key interest rate by 0.75% to 9.5% last Wednesday, up from an historic low of 8.75%, set last July. The move was due to inflationary pressures in the booming Brazilian economy. Brazil’s central bank’s last rate-tightening cycle lasted only six months – from March to September of 2008 – before it was interrupted by the global financial crisis of late 2008, causing rate cuts through mid-2009. It will be interesting to see how long Brazil’s current tightening cycle will last.
- Russia‘s central bank continued its series of rate cuts by lowering its benchmark refinancing rate by 0.25% to a new record low of 8% last Thursday. Analysts at Capital Economics said that this decision “underlines policymakers’ concerns over the sustainability of the economic recovery,” adding that this interest rate cut “will do little to spur lending in the real economy.” Capital Economics also said that the days of aggressive easing are over and Russia’s interest rates may rise in the second half of the year.
- Japan‘s central bank kept its overnight rate unchanged at 0.1%, saying that Japan’s economy “continues to pick up.” Tokyo promised “new efforts” to support economic growth, but it is unlikely to make any big changes to monetary policy. The Bank of Japan forecasted an end to deflation next year, predicting that prices will rise 0.1% in the 12 months to April 2011. It also sharply increased its GDP forecast to 1.8%.
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