The European sovereign debt bomb is ticking

JEAN-CLAUDE Juncker, chairman of the Eurozone’s finance ministers, said yesterday that Greece may have to ask investors to either extend the maturities of its bonds or agree to a soft restructuring. This follows on from the Greek foreign minister Dimitris Droutsas saying that the country was open to soft debt restructuring if needed. But in reality, the markets seem to lack any confidence that the troubled country can halt the vicious cycle of unsustainable bond-yields followed by EU bailout.

A report from Barclays Capital was damning about the ability of Greece to extract itself from its current position. “Greece is in a negative feedback loop in which high restructuring probability implies precarious debt dynamics, while such dynamics imply even higher default probabilities. We do not see any triggers – very high growth or draconian fiscal adjustment – that could move yields from current levels to those (6 per cent or below) needed to stabilise debt dynamics in the near term.” The analysts added that: “In our view, Greece is probably insolvent.”

But Greece isn’t alone in its predicament. On the other side of the Mediterranean, the Portuguese have taken the choice of the rock over the hard place. Faced with unsustainable bond yields, the country did its best Oliver Twist impression, going cap in hand to plead “please, sir, I want some more” from the European bailout fund. They were given a €78bn bailout, which was signed off yesterday.

With eye watering bond yields across the Mediterranean countries, fears abound as to how long the German purse can continue to bail out those profligate nations that have run themselves into trouble.

The German tax-payer is the lynch-pin in the continuation of the European single currency experiment. Though it has come to the rescue of beleaguered economies less well managed than its own, any attempts to write off this accrued debt have faced strong opposition from German Chancellor Angela Merkel. Merkel has shot down any suggestion of allied European forces renegotiating the terms of Portuguese bonds, voicing fears that a restructuring program could lead to a huge amount of investor flight out of Eurozone bonds.

Unfortunately, as her opposition slowed talks of debt restructuring, Merkel may have already exacerbated the investor flight that she wished to avoid in the first place, with the euro taking a buffeting against the dollar over the last week.

“Of most concern to me is that investors are too complacent about the risk of contagion and default in the European bond markets,” says Peter Allwright, Head of Absolute Return Bond Strategies at RWC Partners. “The fact that government bonds are clearly pricing in default and re-profiling to a greater extent than any other asset means someone is wrong and is going to get burnt.”

On top of the worries about the long-term policies of the European finance ministers, the shadow of Dominique Strauss-Kahn’s arrest in the US hangs over discussions. Debates as to his possible successor have threatened European Union peace.

With the subtlety of a Feldhaubitze, the German Chancellor Angela Merkel went on manoeuvres in attempts to position a potential successor to Dominique Strauss-Kahn. “We know that in the mid-term, developing countries have a right to the post of IMF chief and the post of World Bank chief. I think that in the current situation, when we have a lot of discussions about the euro, that Europe has good candidates to offer.”

But these comments struck a nerve with finance minister Juncker: “As long as Mr Dominique Strauss-Kahn has not stepped down, and I’m not suggesting he should do so, I will refuse to give an answer to this question. It’s indecent that some governments already this morning started that debate. It’s a debate which has no place.”

The likelihood is, providing peace in European monetary union can be maintained, the EU will continue to support Greece until the end of this year. By then it is hoped that risk of an Irish or Portuguese implosion will be lower and the risk of contagion correspondingly less. But the vultures will be looking at the soaring – and surely unsustainable – yields on bonds being issued by the debt ridden countries on the Eurozone’s periphary. Should one country fall, in the ensuing domino effect, it is likely that the currency vultures would pick the euro to pieces.