More on Greece

As many commentators have noted, the brewing sovereign debt crisis isn't anymore about Greece than the financial crisis of 2008 was about Lehman Brothers or AIG. All over the world, government balance sheets have become swollen with debt, and in many places private sector debt has been transfered to public balance sheets, with the result that net debt levels have fallen very little.

Some of the immediate effects of the Greek crisis were a widening of sovereign CDS spreads (Spain hit 170bps, the highest level since Feb 09), a sell-off in risk and a broad dollar rally, and a rise in yields on government debt for other Euro area members, albeit with different degrees for different countries. The Euro was battered, with EURUSD hitting a low of $1.34. I recall in October and November 2009, when stories about dollar doom were in papers everyday, that the magic resistance level for EURUSD was $1.45; later in the year, as it broke that level, it became $1.40.

This has taken many by surprise: in a world where currencies everywhere offer derisory yields, many had imagined that the Euro was the safest of the bunch--I had a German colleague who advised me to buy gold or a "real" currency, like the Euro. To an extent this was justified, as it was expected that the usually hawkish ECB would be the first to raise rates in 2010. But Euro area recovery has been feeble at best, and the Greek crisis has made a rate hike more difficult: differentiation within the Eurozone is finally showing, and while some countries can arguably weather a rise, to others it might be unbearable. The result is that you should expect rates in the Euro area to stay low; with the Fed raising its discount rate last week, the EURUSD equation has thus, in a sense, been turned on its head. Has it run its course? I will be an interested observer on how that cross fares, and like I've said before, I expect USD to be a major beneficiary of risk events in 2010-2011.

Finally, I think it is useful (but of course difficult) to look for relative value opportunities that might arise in the sovereign debt space: for example, the Blackrock co-head of fixed income mentioned last week (see story) that while Greek yields nearly doubled Portugal yields on some parts of the curve, the fundamentals in the two countries were not all that different. One of PIMCO's favorite long-term buys is German bunds, especially versus US treasuries and UK gilts. More on that next time!