Eurozone markets have been given a dual wakeup call in Italy and Greece. Just days after Greece’s 10-year yields hit all-time lows of 2.85%, the European Commission has warned that they may not meet their post-bailout budget targets. The warning reflects the loss of focus from the Greek Government. After exceeding their primary surplus target for 2018 – targeting 2.5% and achieving 3.5% – and promising to meet the target up until 2022, Tsipras has since begun a series of expansionary fiscal measures with more in the pipeline. Valdis Dombrovskis, the current European Commission Vice-President, also echoed today’s Enhanced Surveillance Report on Greece in calling the May 15th new fiscal measures “damaging” and “costly, not right”.
Italy was also in the firing lines where according to Dombrovskis, “growth has almost come to a halt” and recent policy choices that are “damaging Italy’s economy” have “not complied with [the] debt criterion excessive debt procedure warranted for Italy”. With the EC announcing that disciplinary process is now “warranted” the European Union have set their disciplinary process in motion which could include as much as an initial €3.5 billion penalty. Greek yields have edged off their lows but remain below 3% and Italy’s 10-year yields have seen a slightly more pronounced 10 basis point move from 2.51% to 2.61%. According to our Relative Value Model the Greek spread of 316 basis points (with 10-year Bunds approaching new lows of -0.23%) remains expensive, and according to our analysis, in particular in our Net Foreign Asset assessment, Greek debts remain at risk of being unserviceable - with even a modest shift in policy or market sentiment toppling the delicate debt structure built upon bailouts and expectations of capital markets remaining open, on-side and at current levels.
In other news regarding Eurozone institutions, Philip Lane began as ECB Chief Economist this week. The former Governor of the Central Bank of Ireland was also one of a pair of authors that helped publish a number of papers on Net Foreign Asset analysis for the IMF. We expect that the Net Foreign Assets perspective of countries will continue to gain sway in how markets, rating agencies and supranational institutions evaluate sovereign credit worthiness ( as well as currency volatility risks) in relation to deleveraging cycles and shocks.