What's with the Spanish Inquisition?
03/11/2011 3:36 pm EST
The debt markets are saying that Spain will make it through the euro crisis without a bailout or a default.
What? Even though Moody’s downgraded Spanish debt yesterday?
Yep, that was a non-event. It’s not so much that the markets disagree with Moody’s move, as that this downgrade has been in the works—and baked into the market—for weeks. The weakness in Eurozone debt yesterday and today is a vote that nothing significant will emerge from the latest round of talks on solving the euro debt crisis.
At the same time, the debt markets are also saying Portugal will need a rescue (34% chance) and that there’s a 60% chance of a Greek default. The markets give Ireland a 40% chance of default.
These reads all come from the market for credit-default swaps. Credit-default swaps give the buyer protection (as long as the guy on the other end of the deal doesn’t go bust) against default of a country’s bonds for five years—for a price. The higher the price, the greater the odds—in the market’s opinion—a country will default within five years.
Working backward from the price of this “insurance,” you can work out the market’s odds on a default taking place.
This week, for example, the average annual cost of protecting against Greek default signaled a 60% probability of default within five years.
On the other hand, the market increasingly believes Spain has cut its budget enough, introduced enough labor-market reforms, and is growing fast enough that the country will avoid a default. The cost of credit-default swaps on Spain has fallen from 3.5 percentage points at the beginning of the year to 2.5 percentage points this week.
Spain still has a way to go before it joins Germany among the elite (German swaps trade at just 0.48 percentage points), but a drop of a full percentage point is significant progress.
Italy is moving in the right direction too, with swaps falling to 1.79 percentage points last week, from 2.4 percentage points at the beginning of the year.
Credit-default swaps for Greece traded at a record 10.35 percentage points on March 8, up from 8 percentage points in February. Irish swaps trade at 5.88 percentage points. Swaps on Portuguese debt trade at 4.97 percentage points, up from 3.87 percentage points in February.
A big part of what distinguishes Spain from Portugal, Ireland, and Greece is economic growth. Spain is growing, while Portugal is showing signs of slipping back into recession—and Greece has never crawled out of its slump.
This all translates into lower interest rates for Spain and rising rates for Portugal, Ireland, and Greece. Portugal did manage to sell $1.35 billion in bonds due in 2013 on March 8, but buyers demanded a yield of 5.993%. That compares with a 4.086% yield at Portugal’s September 2010 bond sale.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of January, see the fund’s portfolio here.