GREECE IS THE SIDE SHOW; SPAIN´S THE MAIN ACT / BARRON´S ( VERY HIGHLY RECOMMENDED READING )

International Trader - Europe

SATURDAY, JUNE 16, 2012

Greece Is the Sideshow; Spain's the Main Act

By JONATHAN BUCK

 

 Central banks are poised to boost liquidity to counter any negative market reaction this week to the elections in Greece.



Sure, the Greek vote Sunday, which takes place after Barron's goes to press, could disrupt markets, especially if opponents of the multinational bailout form a coalition, or parties fail to broker a deal and there is no government at all.



But the sovereign-debt crisis has progressed so much that Greece is now little more than a sideshow. The biggest danger Greece represents is contagion. Its long-term future in the euro zone is doubtful, even if parties that endorse the country's bailout cobble together an alliance that lets them govern.



However, Greece's tepid commitment to austerity and reform seems destined to end its membership in the euro club before 2014. The wrong election result for investors would accelerate capital flight, advancing the end game. Some companies aren't hanging around: French supermarket giant Carrefour (CA.France) says it is pulling out of Greece. It won't be the last company to do so.



Whatever happens in Greece will have little bearing on the main battlefront—the euro-zone banking system. Spain last week accepted a rescue package worth up to 100 billion euros ($126.5 billion) to recapitalize its banks, which were sapped by bad loans from a burst real-estate bubble. The rescue raises more questions than it answers—not least, where the money will come from. "The bailout is not a solution," says Alberto Gallo, head of European credit strategy at Royal Bank of Scotland in London. "It shifts the burden from the private sector to the public sector." That doesn't sit well with investors, who are pushing up Spain's borrowing costs almost daily. The yield on its 10-year bond rose to 6.838% Friday from 6.536% at the end of last month, reflecting heightened anxiety that a bailout will be necessary—something Europe can ill afford.



Italy's destiny seems inextricably linked to that of Spain, although its problems are mostly political, not economic. The yield on Italian 10-year government bonds hit 5.912% Friday. Even German yields rose, with 10-year bunds trading Friday at 1.436%, compared with lows of 1.172% just a couple of weeks ago. That suggests uncertainty about the costs that Germany could incur to prop up the rest of the euro zone.



Moody's Investors Service and Egan-Jones Ratings last week downgraded their ratings for Spain. Moody's now rates Spain one notch above junk; Egan-Jones rated Spain at junk even before its latest move. Without a change in its economic fortunes, or some sort of intervention, Spain soon could have trouble accessing capital markets to fund itself.



Spain remains keen to avoid a full-scale bailout with onerous conditions. The experiences of Greece and Portugal show the benefits don't last long. "The patience of the market is wearing thin," says Steve Wood, chief market strategist for North America at Russell Investments. "The half-life of the policy-response euphoria is getting very short."



In pre-emptive strikes to prevent post-election selloffs, central banks signaled that they stand ready to calm markets. Amid reports that the G-20 is mobilizing, the European Central Bank indicated Friday it is prepared to provide liquidity to banks. A day earlier, the Bank of England said it would offer cheap funds to U.K. banks, if the money is used to provide loans to consumers (although it is unclear whether demand is there). Friday, U.K. bank stocks gained on the news. The U.S.-traded shares of Royal Bank of Scotland (RBS) rose 9.7%, to $7.83, Lloyds Banking Group (LYG) climbed 4.4%, to $1.92, and Barclays (BCS) advanced 4.9%, to $12.70.


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Ultimately, closer fiscal integration and the mutualization of debt—meaning eurobonds—is needed for the euro zone's long-term viability. That will include a pan-European banking response, including a guarantee on deposits. "Essentially, Europe is going to have to make a move toward something like a United States of Europe," says Russell Investments' Wood. And quickly.


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THE STOXX EUROPE 600 INDEX closed Friday at 244, up 0.9% on the week. Spanish equities gained 2.5% following the bank bailout. Nokia's (NOK) shares plunged almost 18%, and Moody's busted the Finnish cellphone maker's credit rating to junk status after it announced a profit warning for the second quarter.

Hopeful

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Spanish equities jumped, on news of an international bailout for its troubled banks.

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