July 25, 2011

Europe’s Market Euphoria Over Greek Rescue Turns Sour

Investors increasingly view sovereigns as risky; money markets continue to cut exposure to euro banks

greek flagEuropean markets gave back gains made on initial euphoria over last week’s Greek rescue plan, with the bond market in particular voting no confidence.

Bond yields on Spanish and Italian debt reached near record levels Monday. The Spanish 10-year bond reached just under 5.8% and the Italian 10-year bond 5.45%. A yield of 6% is considered by many financial analysts to put sovereign debt on an unsustainable path.

European stock markets, which skyrocketed on the Greek rescue plan last week, also retreated on Monday. The biggest gainers last week were Spain’s IBEX 35, which rose 6.06% on the week; and Italy’s FTSE MIB, which rose 5.48%. On Monday, the two indexes fell 1.8% and 2.5%, respectively.

Euro zone leaders meeting Thursday in Brussels crafted an ambitious proposal–which they described as a “European ‘Marshall Plan’”–aimed at staunching contagion; the plan doubled the time within which Greece could repay debts and eased the interest cost of those repayments.

The European leaders for the first time also allowed for a “haircut” to private investors, a move that made the deal politically more feasible, but which is already having adverse, though expected, repercussions in Moody’s downgrading of Greek debt to one notch above default on Monday.

Bond investors appear to be increasingly taking the view that sovereign debt is a high-risk investment. BNP Paribas analysts are quoted as saying “investors are giving priority to safe investments and are switching to high quality assets, leaving aside those considered risky.”

Ironically, BNP’s own securities are considered just such a risky asset by U.S. money market funds, which are continuing to decrease their exposure to European banks.

TheStreet.com reports that French banks are particularly exposed to sovereign debt of Euro-periphery countries, and that BNP Paribas alone has nearly half the group’s exposure to Italy. BNP shares slid 4.33% Monday in Paris.

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