The difficulties facing the smaller economies in the European Union have made daily headlines for months now. Within the past year, several EU-member nations have been on the wrong end of a credit ratings downgrade, and given current conditions, the likelihood of further cuts grows with each passing day.
It has been just over a year since Spain saw Standard & Poors reduce its credit rating from AAA to AA+. S&P also trimmed Portugal’s credit worthiness rating from AA+ to AA-. Despite these moves, it appears that Greece remains the weakest link in an already flimsy chain as S&P downgraded Greece’s rating to BBB+ this past December. This is the lowest of the “Investment Grade” ratings, but the reality is that, for a sovereign nation, this is really the equivalent of “junk” status. Worse still, S&P has warned that given the downside risks of dealing with Greece, further cuts are not out of the question.
“If public support for the government’s stability program decreases from its current level, compromising its execution, we could also lower the rating,” noted S&P analyst Marko Mrsnik in a statement released February 24th.
Seeing that – even as I write this – Greece is in a state of lock-down, I would guess that “public support” is a bit on the light side. Schools are shuttered, the airports are offline, and public transit is shut tight as protestors take to the streets in the thousands. All this in reaction to the government’s first attempts at reigning-in spending, which so far, have consisted of a lot of talk, but little action. Imagine the outcry when the austerity program actually kicks in.
In addition to dramatic spending cuts, Greece must raise in the order of $54 billion this year to cover its budget shortfall. At its bond sale last week, Greece was forced to increase the yield on its 10-year bonds to attract sufficient buyers to ensure a successful sale. The yield spread, when compared to Germany’s equivalent bond, jumped 11 points over the previous sale to 297 basis points. Demand was strong, but it is clear that investors see this as an opportunity to buy high-yielding bonds, ultimately, backed by the collective strength of the entire EU. Buyers are clearly betting on a rescue package should Greece be forced to default.
