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Prospects Daily: Default risk for European sovereign and bank debt at record high

Global Macroeconomics Team's picture

Important developments today:

1. Global equities retreat amid Greek default concerns.

2. Default risk for European sovereign and bank debt rise to new record highs


Global equities retreat amid Greek default concerns. World stock markets plunged on Monday, continuing last week’s downward trend, as investors’ fears over the possibility of an imminent Greek sovereign default intensified amid signs of discord among Euro-zone policy makers over how to resolve the region’s debt crisis. Europe’s benchmark stock index plummeted to its lowest level since July 2009, led by banking stocks, while the euro fell to its lowest level since 2001 versus the yen as speculation mounted that the German government is preparing itself for an orderly restructuring of Greece. Notably, French banking stocks lost around 10% on concerns that major French banks might be downgraded by Moody’s Investors Service this week due to their high exposure to Greek sovereign debt. Emerging-market stocks fell as well, dragging the benchmark MSCI index to its three-week low, with benchmark indexes in Hungary, Poland, and Russia dropping by more than 3%. U.S. equities also opened lower, with S&P 500 index falling 0.5% in morning trade.

Default risk for European sovereign and bank debt rise to new record highs. The cost of protecting against default on European government-and private banking sector debt surged to fresh highs amid speculation that Germany seems to be preparing for a Greece default, while France’s three biggest banks (by market capitalization) may be downgraded this week because of their Greek debt holdings. Markit iTraxx Sov-X Western Europe Index of credit-default swaps (CDS) on the debt of 15 governments surged 15 basis points (bps) to 351bps; at the same time, the Markit iTraxx Financial Index of swaps on 25 European banks and insurers increased by 17 basis points (bps) to 317 bps, according to JP Morgan Chase. Meanwhile, CDS spreads on Portugal, Greece, Italy, and France all surged to record highs, according to CMA.

For first time in four quarters, business sentiment turns positive in Japan. Despite the strong yen and faltering global economic growth, business sentiment among major Japanese companies over the July to September period rose, according to a survey carried out by the Finance Ministry and the Cabinet Office.  The business sentiment index, which reflects the percentage of firms that see improvements in business conditions over those that do not, rose to 6.6 for big companies – higher than the minus 22.0 recorded in the previous quarter, and the first positive reading in four quarters.  Much of the improvement in sentiment was largely due to the recovery in supply chain disruptions due to the March earthquake. Indeed, the sub-index for automakers and autoparts rebounded from minus 75.4 in the previous quarter to plus 71.4 in Q3 2011.  However, other economic data released today points to ongoing fragility in Japan’s economic recovery, with tertiary industrial activity down 0.1% in July.

Among Emerging Markets

In Central and Eastern Europe and the CIS, the Turkish economy posted growth of 8.8% (y/y) in the second quarter, while first-quarter growth was revised up from 11% to 11.6% by the Statistics Institute. In seasonally adjusted q/q terms this amounts to 1.3% growth in Q2, following 1.7% growth in the first quarter. The pace of growth remains robust following a cut in the benchmark interest rate to a record low of 5.75% last month.

In South Asia, India's industrial output growth dropped to 3.3% (y/y) in July from 8.8% annual growth in June, the slowest pace of growth in two years as the Reserve Bank's repeated interest rate hikes took effect at slowing down growth. The benchmark repurchase rate has been hiked by a total of 325 basis points since March 2010, and more tightening expected at this month's policy meeting despite the drop in industrial output. Inflation, measured by the wholesale price index, accelerated in August to 9.64% from 9.22% in June.  

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