Friday, January 23, 2009

10Yr Gov’t Bond Spreads in the EU



Above is an interesting chart showing the widening spreads of some of the most at-risk EU countries including Italy, Greece, Spain, and Ireland. Reflecting the country’s deflating housing bubble and weakening economy, S&P downgraded Spain’s sovereign credit rating from AAA to AA+. Shockingly, Ireland’s rating is still AAA, despite the recent nationalization of Anglo Irish Bank (Ireland’s 3rd largest bank) and expectations for a GDP deficit of as much as 9.5% in 2009. As pointed out by several pundits, Ireland is contending with a deflating housing bubble far more severe relative to the size of its economy than is the United States.

With the diverging fortunes of the countries composing the EU, I wouldn’t be surprised to hear rumblings about breaking up the union. Two key tests must be met in order to comply with EU rules: 1) government deficits must be less than 3% of GDP and 2) government debt must be less than 60% of GDP. However, preliminary forecasts suggest that all the aforementioned countries will violate one or both of these provisions in 2009. While failing to meet these minimum thresholds will likely be tolerated in 2009 (what choice do they really have!), the strength of the euro could be compromised if creditor nations begin to lose confidence in the currency. My own personal belief is that the likes of Germany will not want to be dragged down by its weaker peers.

In my opinion, Spain appears most at risk and I have reflected that view by being short the etf EWP over the last year. This September 2006 WSJ article awakened me to the impending housing bubble facing the country. ("Spain's Housing Boom Faces Test".)

The following paragraph from the article sums up the mess pretty clearly - “Despite millions of empty homes, construction activity appears to be picking up. Spain has been building more houses than France, Britain and Germany combined for the past five years straight. In the first half, housing starts accelerated to 15%. Spain, with 44 million inhabitants, is on track to build 760,000 new homes this year, nearly half as many as the U.S., which has a population that is seven times as large."

The canary in the coal mine came with the July 2008 bankruptcy of Martinsa-Fadensa, Spain’s largest property company. As the slow moving train in the US has taught us, it is only a matter of time before a slowdown in the construction sector begins to infect the rest of Spain's economy.

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