With a rush, financially-pressured Ireland is back to worry the markets after the cost of its debt jumped sharply and spreads over German bonds widened.
But unlike earlier this year, the return of the euro fears have had little impact on other markets such as the US or Australia where they are being all but ignored.
They shouldn’t.
The worries about Ireland haven’t happened overnight, the strains of financing the deep budget spending cuts and keeping skittish markets happy have been growing in the last month or so.
The cost of debt jumped every day this week and on Thursday, ratings group, Moody’s said it is awaiting the release of Ireland’s four-year fiscal plan later this month to decide whether to downgrade the country’s credit rating.
Irish bond yields hit new highs of 9.0% overnight Thursday, while the extra cost Spain and Italy have to pay to raise funds compared to the benchmark German bond jumped to levels not seen since the euro was introduced in 1999.
The euro fell to a month low against the US dollar and sharemarkets wobbled (helped by a bad earning report from Cisco in the US). Gold and copper rose.
In effect, the markets are now saying Ireland, along with Portugal, are heading for either collapse or a rescue similar to the one Greece was forced to call for earlier in the year. Italy is also being regarded increasingly in a similar way by investors.
Markets now fear that Ireland’s latest austerity plan won’t bridge the budget gap, no matter how deep the cuts are.
The new plan is due late this month and the Irish Government said overnight it planned to get it through the parliament by December 7.
The ratings agency put Ireland’s Aa2 ratings on review for a possible downgrade on October 5, citing the impact of additional bank recapitalization needs, increased uncertainty regarding the economic outlook, and elevated borrowing costs.
Ireland’s borrowing costs soared to all-time highs on Thursday and a possible rating downgrade could send Ireland’s debt spreads even higher.
Among the big rating agencies, Moody’s currently gives Ireland the highest credit rating, eight notches above junk status. Standard & Poor’s has the country seven degrees above junk, at AA-minus, while Fitch has it one step below S&P, at A-plus.
Moody’s is particularly concerned about Ireland’s ability to preserve the government’s financial strength in a difficult economic environment and the four-year financial plan will be key for the government to preserve public finances and bring the deficit below 3% of gross domestic product by 2014.
But growing scepticism Ireland can withstand another 6 billion euros of cuts next year, keep cost of its bank bailout around 50 billion euros, and raise more money after next April, has undermined the country’s standing in the eyes of markets.
Hence the escalation in bond yields and the spread with German bonds for the past 13 days.
The European Central Bank has been forced to re-enter the markets to support Ireland by buying debt in the past 10 days.
And while the euro has dipped, we’ve not yet seen a repeat of the sell off of April and May.
But more worrying was the move by a London clearing house (which handles financial transactions such as bond and other deals) to lift the amount of collateral needed to deal in Irish bonds (through repo, or repurchase agreements) to 15%.
Media reports said the LCH.Clearnet has contacted members saying it was imposing a 15% “haircut”, or cash deposit to help indemnify against default risk, against Irish bonds if it fears the risk of the Irish government defaulting has increased.
There was a warning a week ago this might happen, and then it did, sending the market in Irish government debt into a spin.
"In the eyes of bond market investors, the prospect of an Irish bail-out, similar to that of Greece, is growing by the day. Yields on Ireland’s 10-year sovereign debt saw their biggest one-day surge since the launch of the euro on Wednesday, jumping more than half a percentage point to 8.64 per cent.
"The extra cost of borrowing over the “risk-free” rate of Germany spiked to 6.19 percentage points, also a record since January 1999.
"At the heart of the volatility in the eurozone bond market, according to investors, was a decision by one of Europe’s biggest clearing houses, LCH.Clearnet, to require banks or institutions wanting to use Irish bonds as collateral in the repurchase markets to raise cash to pay an extra margin of 15 per cent."
This means those using Irish bonds as collateral will now get 85% or less of the face value of the bonds.
The move forced Ireland’s struggling banks to find more cash to maintain their positions. There was talk of the banks having to find up to $US1 billion of new cash to post as new collateral.
Market and media reports drew comparisons with Greece in the run-up to its 110 billion euro earlier this year bail-out by the European Union and the International Monetary Fund.
Ireland has said that its government funding needs are covered until next June, and that there is another 12 billion or so euros in state pension funds available.
But Ireland will have to start getting new money from the market in the first quarter of the year at the latest. It should really be looking for a bond issue before the end of the year.
At these spreads it can’t and the
