Following the sell off in peripheral fixed income markets in recent days the pressing issue for Europe and the IMF is now how to contain risks with the Greece panic spreading over to Portuguese government bonds and other peripherals such as Ireland. S&P added fuel to the fire yesterday by downgrading Portugal by two notches from ‘A+‘ to ‘A-‘ (‘negative’ outlook) and cutting Greek debt to junk from ‘BBB+’ to ‘BB+’ (‘negative’outlook) and assigning a recovery rating of ‘4’ to the latter. Such a recovery rating of '4' reflects an average of 30%-50% recovery value for holders of Greek government by S&P’s standards in the case of a default. While Greece is still rated better by Moody’s (‘A3’ negative) and Fitch (‘BBB-‘, negative) than the ECB’s current collateral threshold of at least one ‘BBB-‘ rating, Euro Government spreads are marked wider and wider with liquidity disappearing.

Eurozone Government bonds lost 1.1% so far this month with Greece down 18.6%, Ireland down 4.6% and Spain loosing 1.8%. This has so far been partly offset by gains in the AAA rated countries of about 0.9%.
So far the EU and the ECB both insist that there will be no debt restructuring for Greece and that Greece will be supported by the EU and the IMF. However, it seems that Greece will need support over a 3 to 5 year period while the EU/IMF plan only talks about initial 1 year support. As such the market and now S&P have come to the conclusion that Greek debt will have to be restructured eventually. Medium and long dated Greek bonds are traded on a price bases, although with low liquidity. It seems that the market is anticipating a 30% haircut for Greek bonds as Greek Government bonds with a maturity of 2015 and longer are all priced around 70%.

Over the coming days bond markets face the risk that uncertainty will further extend to all peripheral markets. Already ten year Portugal is trading 2.65% over Germany while ten year Ireland has moved to 2.17%, being as low as 1.3% earlier in the month. EU officials have pointed to the EU leaders summit on May 10th as a possible solution, but markets need an earlier solution than that. Emergency meeting can be expected over the coming days with a solution needed over the weekend, especially as the crisis has now extended into global equity markets with the S&P down 2.4% overnight.