Jumping at shadows
The financial markets have been waiting for and indeed, looking for, the aftershocks from the GFC since the end of the third quarter of last year. Early to mid October generally marks the high point for equity markets and the narrow point for credit spreads.
Since then the ride has been volatile, with markets alternating between concern over proposed banking reforms and contagion risks posed by potentially failing sovereigns. In the case of the former, the focus has been on increased capital and liquidity requirements, reduced gearing levels, restrictions on undertaking certain activities and even the break-up of banks too big to fail.
In the case of the latter, Dubai had markets in a flurry from late November until just before Christmas but by then concern was starting to swing towards Greece.
With the markets now focused on Greece, and also Portugal, Spain and Italy (which enables the wonderful acronym - PIGS), it is now pretty much a case of Dubai who?
The point is that markets are jittery and may be jumping at shadows - the risks may not be as great as feared.
As Moody's pointed out in a report released earlier in the week, concerns about the ability of Greece, Portugal and Spain to roll over their existing debt and finance their ongoing budget deficits have so far not been substantiated by hard evidence.
Moreover, is it logical that some of Markit's sovereign CDS indices have moved to levels that are wider than its corporate CDS indices? Could this be a crisis created by sovereign CDS traders?
At their peak early last week Markit's SovX Western Europe and G7 Series 2 indices had widened by 124 per cent and 107 per cent respectively, since the end of October last year.
Admittedly, these movements reflect the impact of Greece and contagion risks posed by Greece, particularly in the case of the G7 index. CDS spreads for Greek sovereign risk have widened by 317 per cent over the same period.
As for perceptions of corporate credit risk, as measured by the European Main, North American CDX and Australian CDS indices, these have barely moved.
Europe is up by six per cent, North America is down by two per cent and Australia is up by 16 per cent. North America, primarily the US, has benefited from a general flight to quality by investors (clearly this is a fear factor) and Australia has not.
Markets rallied in the middle part of last week as expectation built for an EU bail-out of Greece, but these hopes were dashed when EU leaders expressed their support for Greece and said help would be provided if needed but no other details were forthcoming.
However, a pertinent point was made - Greece has not asked for assistance. What the EU is trying to do at the moment is assuage market concerns and restore some confidence.
In doing so, it must tread carefully. For one thing, EU rules do not allow a bail-out of failing member countries and there is the critical issue of moral hazard associated with any assistance that is provided.
This is the most serious crisis that the euro has faced in its 11-year history and it demonstrates the practical problems that exist when monetary union is imposed without the creation of a true federation. The United States of Europe does not exist; there is only a loose grouping of 27 sovereigns, 16 of which have a common currency.
The new EU President, Herman Van Rompuy, wants to use this crisis to push for the creation of a new form of "economic government" in Europe. He argues that there needs to be a common European strategy for economic growth, steered by the 27 European leaders.
Hopefully, more details of the tangible measures that will be taken to assist Greece will emerge from the meeting of EU finance ministers this week and this will quickly restore confidence to financial markets. Because any additional measures required to increase the structural stability of the euro, will be argued for a long time.