Report From the PIIGS

Eurozone auctions continue to shrug off debt downgrade

Spain and France successfully completed another round of debt auctions Thursday. This was a key auction for Spain in particular, who already had a successful auction earlier in the week—but many believe that shorter-term debt auction was likely aided by the ECB’s three-year unlimited liquidity operation. In total, Spain auctioned off €6.6 billion of debt Thursday, far exceeding its €3.5 to 4.5 billion target. Benchmark 10-year yields fell to 5.403% from 6.975% in November. Evidently, markets continued to shrug off Standard & Poor’s debt downgrades from last week.

France, another victim of S&P’s downgrade spree, successfully auctioned off nearly €9.5 billion of debt, mostly two, three and four year maturities (a relatively small amount of long-term, inflation-linked securities were also sold). French yields were also lower—two-year yields fell around 50 basis points from an October 20 auction last year.

It’s rumored more downgrades may be on the way as Moody’s and Fitch play follow-the-leader with S&P. However, thus far, markets seem indifferent to the raters’ mood shifts. Not surprising, since in our view the agencies’ opinions merely confirm what the markets have already long known and sufficiently priced into markets.

Greek haircuts

The Greek government and its private-sector creditors appear close to a deal that would cut Greek debt by as much as €103 billion and shave nearly €4 billion in interest costs annually through 2015. Recall, an agreement with its private creditors to accept a haircut on debt is necessary for Greece to secure a €130 billion bailout from the IMF and other eurozone partners. Negotiations start Friday.

Under the terms of the deal, Greece would swap current debt for new debt written down by 50%. However, terms of the swap—mainly interest rates on the new debt—have been the subject of contention, with talks nearly breaking down several times over the course of the last week. The creditors’ representatives demanded an annual coupon of 4%-5%, whereas Greek officials have countered with a 3.5% rate.

As with all things PIIGS related, we expect the political back-and-forth on both deals to be rancorous and to go down to the last minute. Parties on both sides are incentivized to get the best deal they can, but ultimately (and as they’ve shown time and time again), they find ways to reach accord at the last possible minute. We expect little to be different this time.

Ireland crosses the first hurdle

Lastly, Ireland appears to be leading the austerity pack among the PIIGS. Thursday, troika officials reported Ireland successfully passed its first austerity hurdle under terms agreed to in its November 2010 bailout, pushing its 2011 budget deficit under 10% (the target was 10.6%). Ireland managed to tackle its fiscal woes by aggressively enacting austerity measures and maintaining measures to promote economic growth (like its enviable low corporate tax rate).

While challenges remain (Ireland still needs to meet a budget deficit target of just 3% by 2015 under the same terms), the country’s progress toward agreed-to bailout term targets should continue. In our view, Ireland’s progress and public will to continue enacting necessary measures underscore the PIIGS are by no means equal. (A topic we’re discussed before here and here.)