THE rest of the world might have been watching Korea, but in Europe, murmurs of a renewed sovereign debt crisis have been turning into a cacophony. Thanks to an audacious austerity plan, Ireland was looking like it had avoided the wrath of the bond markets, but last week, the fear was back. For holders of Irish debt, such as Royal Bank of Scotland (RBS), and for Irish banks such as Allied Irish Banks (AIB) or Bank of Ireland, the fear has translated into dramatic share price losses. Spread betters should take note this morning.
Helped on by comments from Germany’s Chancellor, Angela Merkel, yields on Irish sovereign debt leapt up to nearly 9 per cent on Thursday, before dipping back on Friday. There was more talk on Saturday and Sunday. Though Ireland has enough cash reserves to last until spring, the fear is that the blanket bailout for Irish banks may cost far more than Irish – or European – taxpayers are willing to accept. Ireland’s banks are estimated to have lost €85bn, 55 per cent of Eire’s GDP.
If Ireland were forced to default or restructure its debt, bondholders like RBS would suffer sizeable losses, while the bailed out Irish banks would almost certainly be wiped out. The possibility of that happening has driven down the share price of RBS by 18 per cent over the last two months, while AIB’s bond yields were pushed up to 31 per cent on Thursday. As Simon Denham, of Capital Spreads put it: “The knives will be out for any bank with exposure in the Emerald Isle”.
The question for spread betters is whether the fear is justified. Analysts at Merrill Lynch Bank of America think that it isn’t. In a report, they said, “the market is effectively pricing in a materially worse scenario than currently expected”. In particular, they argue that RBS has lost so much value recently that even in the most pessimistic outcome, it would probably still prove to be undervalued. Spread betters might be wise to go long then.
But perhaps only for a little while. In the view of Michael Hewson of CMC Markets this latest crisis is more than simply a panic. He says that Irish austerity “will only defer the inevitable”. And when it is actually needed, the tacitly promised European bailout may prove difficult politically – as Angela Merkel’s comments suggested. Spread betters need to be very wary then. Ireland is clinging to a cliff face. It may not fall yet, but neither will it pull itself up quickly. This latest panic should blow over, but confidence will not always be quickly restored.