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Facts about Greece to Consider

05/15/2012

Political developments in Greece over the past eight days have placed the eurocurrency back in a vulnerable position and elevated the stress within European sovereign credit markets. U.S. and German government bonds are experiencing “flight to safety” buying, while growth-challenged core EU sovereign bond yields are rising uncomfortably once again. 
 
Some points to consider…
 
In the near term:
•    Greece has been unable to form a coalition government since its elections on May 6
•    An inability to form a coalition government will force new elections in June
 
New Greek elections in June mean:
•    Continued speculation on a Greek exit from the euro
•    Greece will, in essence, be voting in June whether to stay in the euro
•     Elevated uncertainty on whether the “troika” (EC, ECB, IMF) will cease funding to Greece
 
How markets digest new elections:
•    German and U.S. Treasuries remain well bid
•    The eurocurrency challenges the lower end of this year’s trading range
•    Longer term euro core and periphery sovereign bond yields remain elevated
•    Global capital markets remain in a corrective state
 
My expectations:
•    The ECB’s plan for a Greek euro exit is already in place, signed off on and shared with global counterparts
•    Greece’s exit from the euro will not initiate a eurocurrency free fall
•    I am focused on the short end of the government bond curve in Europe; that is where the ECB will focus as well
        o   Example, Spain’s 2-year is trading at 4%, well below the 6% of November 2011
        o   The LTRO has very successfully anchored short-term yields
•   Continued weakness for the eurocurrency will have beneficial impact on the German economy in the second half of 2012
•    Recapitalization of Spain’s banking system is headwind number one from Europe and my main focus
        o   Spain’s banks need to further write down losses on the burst housing bubble
        o   Spain needs a similar commitment to what Ireland provided its banks
•    Even if Greece exits the euro, I expect the ECB will continue to provide funds to prevent a Greek banking collapse
  
Final thoughts:
This blog’s purpose is to provide an informative, factual response to the multiple inquiries I have received in response to alarming European headlines. However, quite candidly, I am more concerned about the mechanism by which Spain recapitalizes its banks than Greece exiting the euro. I also suspect that much of the overall S&P 500® Index (SPX) weakness this week is attributable to the fallout from JP Morgan’s Thursday afternoon press conference. Unfortunately, the ability of financial institutions to grow revenues will be questioned once again. More importantly, a reactionary response by D.C. policy makers toward stricter financial regulation will take the focus away from the tackling the 2013 fiscal cliff.     
 
Figure 1.1 German Bund 10-Year Bond Year To Date

Source: Bloomberg
 
Figure 1.2 U.S. Treasury 10-Year Bond Year To Date

Source: Bloomberg
 
Figure 1.3 Eurocurrency Year To Date

Source: Bloomberg
 
Figure 1.4 Spain 2-Year Yields Prior Year

Source: Bloomberg
 

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.