Sovereign debt crisis update: Yields hitting new highs in Greece, Ireland, Portugal, and Italy.

Interest rates are hitting their highest levels since the euro zone was created. Here are the five most “at-risk” countries, in order of chances of default.

Greece

 

Ireland

 

Portugal

 

Spain

 

Italy

Sovereign debt crisis: Here we go again.

Moody’s cuts Greece rating, stokes debt fears:

Moody’s Investors Service cut Greece’s sovereign-debt rating Monday by three notches to B1, infuriating the Greek government and temporarily denting the euro amid renewed worries about the ability of Greece and other debt-loaded euro-zone governments to avoid default.

The ratings agency, which also assigned a negative outlook to Greece’s ratings, highlighted the government’s difficulties with revenue collection and noted a risk that Athens might not meet the criteria for continued support from the International Monetary Fund and the European Union after 2013.

That could result in a voluntary restructuring of existing debt, the ratings agency said.

[…] The spread on Greek five-year credit default swaps widened 27 basis points to 1,010 basis points, according to data provider Markit. A basis point is 1/100th of a percentage point.

That means it would cost $1.01 million annually to insure $10 million of Greek debt against default for five years, up from $983,000 on Friday.

[…] The yield on Greek 10-year government bonds rose to 12.12% Friday, moving back above the 12% level for the first time since January, Jenkins noted, while the two-year spread had hit 15.22%.

It’s not just Greek yields that are rising. Portugal’s 10-year yield is hitting new highs. Many suspect that Portugal will be the next domino to fall, followed by Spain, and then Italy. Italy’s yield is also hitting new highs.

And the sovereign debt crisis continues, just as I’ve been saying it would…

Sovereign debt implications of Middle East turmoil

Disregarding the discussion about the political effects of the protests in the Middle East, how about the financial implications?

The cost of protecting sovereign debt against non-payment in northern Africa and the Middle East continued to rise Tuesday as investors reacted to ongoing turmoil in Libya. Morocco was hardest hit, with the spread on five-year credit default swaps widening to 200 basis points from around 184 on Monday, according to data provider Markit. That means it would cost $200,000 annually to insure $10 million of Moroccan debt against default for five years, up from $184,000. The Egyptian CDS spread widened 19 basis points to 375, Markit said, while Bahrain’s spread widened 10 basis points to 317. The Israel CDS spread widened to 163 from 154.

Losses by banks in this region will only hurt the important countries’ fiscal situation.

Looking at Portugal, now the key country, interest rate are new highs.

The turmoil in the Middle East just adds a new twist to the sovereign debt crisis. Until nations reduce their debt levels, which none are doing right now, this story is far from over and will be around for years to come.

A broke Japan bails out Europe

So now Japan is bailing out the at-risk Euro countries.

Japan on Tuesday threw its support behind Europe’s bailout efforts, saying it will take a major stake in a bond offering for Ireland later this month by one of the special funds set up in the wake of the euro-zone sovereign debt crisis.

The government plans to buy more than 20% of a bond offering by the European Financial Stability Facility, expected some time this month, Finance Minister Yoshihiko Noda said at a press conference. The EUR440 billion fund was set up in June 2010 to help finance bailout efforts.

But where exactly is Japan getting the money from to buy these bonds? Japan’s been running big deficits for years and has debt of 201 percent of GDP, much larger than those European countries. But Japan pays almost nothing in interest rates on its own debt and is buying higher yielding bonds, profiting from the spread.

From a more macro viewpoint, Japan is monetizing the Euro debt just as the Fed is monetizing the US debt. But the difference is huge. These Euro countries are much closer to defaulting than the United States is and the spread between short-term Japanese rates and long-term Euro rates is much larger than the spread between short- and long-term rates in the US. Though Japan’s purchase is “only” 88 billion Euros compared to the Fed’s $600 billion in QE2 alone, Japan has a smaller economy and is taking a much larger risk.

The Yen and Nikkei index fell after the news. Japan should worry about its own fiscal and economic situation before trying (and likely failing) to help others.

Sovereign debt crisis spreading to first world countries.

I’ve written about the sovereign debt crisis numerous times already. See here, here, here, here, and here. But so far, I’ve only written about those “at-risk” countries such as Portugal, Greece, Spain, and Ireland or individual states such as Illinois. In other words, the sovereign debt crisis has so far been limited to “small” countries or states. Debt defaults among these countries or states certainly would cause problems and a sharp decline in financial markets, but likely wouldn’t break the bank. But if this crisis spreads to larger, more financially important countries, it would obviously have a much larger impact, possibly one similar to the stock market crash of 1929.

Marketwatch reports that the sovereign debt crisis may in fact be spreading to a first world nation:

There’s no ‘B’ in PIIGS, but Belgium could eventually cause headaches of its own for the euro zone if a bitter and protracted political fight prevents the country from hitting its deficit-reduction targets.

Belgium, in northern Europe, has seemed an unlikely candidate for sovereign-debt troublemaker. From a fiscal perspective, the country, whose capital Brussels is the home of the vast EU bureaucracy, has been associated more with the so-called core of the euro zone than the troubled “periphery.”

But an increasingly bitter political divide along linguistic lines has left Belgium without a government since April and is beginning to raise some concerns.

Belgium, which has enjoyed solid growth, appears on track to reduce its budget deficit to 4.8% of gross domestic product this year from 5.6% in 2009, economists said. The nation’s deficit is among the lowest in the euro zone and compares well with other core countries, including Germany at 4.5% of GDP, France at 8% and the Netherlands at 6%.

But if a government isn’t formed soon, the 2011 fiscal target of a reduction to 4.1% could be in jeopardy, said Philippe Ledent, an economist at ING Bank in Brussels. That in turn would make it all the more difficult for Belgium to meet its target of bringing its deficit down to 3% of GDP, the EU limit, in 2012.

In reality, a 4.1%, 4.8%, or 5.6% don’t seem too bad, especially considering the 10.6% deficit here in the US for 2010 and 8.3% deficit expected for 2011.

Belgium’s deficit figures raise few alarms, but government debt stands at around 100% of GDP, which compares more closely with Greece and Italy.

U.S. debt, by comparison, also stands at about 100% of GDP.

The financial markets are starting to notice Belgium’s problem:

Belgium has had no problems selling its government bonds. Borrowing costs have risen, however, with the yield premium demanded by investors to hold 10-year Belgian debt over benchmark German bunds standing at around 0.8 percentage point, up from around 0.4 percentage point around the same time last year.

But borrowing costs are far from problematic, Ledent said. Belgium’s premium remains nowhere near comparable to Spain’s, for example, which is at around 1.6 percentage points, much less Ireland’s at around 4 percentage points.

The cost of insuring Belgian debt against default is up sharply since the April elections, but well off the peak seen in mid-June. The spread on five-year sovereign credit-default swaps was at 119 basis points last Thursday, according to data provider CMA. That means it would cost $119,000 a year to insure $10 million of Belgian government debt against default for five years.

The spread stood at around 60 basis points in mid-April before the latest round of political turmoil and peaked at 149 basis points in late June.

“Up to now, there has been no strong impact [on borrowing costs], but I’m not sure it will continue like that,” Ledent said. “If in two, three, four months we still don’t have any government, financial markets will consider that we won’t reach the [budget] target and then there could be an impact on the spread.”

How long can countries like Belgium or the United States continue to borrow at low interest rates? These are countries with deficits exceeding 4% of GDP, in Belgium’s case, or 8-10%, in the United States, with debts equal to 100% of GDP. Logic tells us that in these countries, either taxes have to rise significantly or government spending has to fall sharply. Neither Belgium nor the U.S. is doing much to reduce their deficits and even less to cut government spending. Both countries, along with all other nations, are hoping for and relying on an economic recovery to lift their finances. What if we enter another recession? What if the recovery is slower than they expect, as it has been so far? All this talk of deficit reduction will be gone and we’ll be looking at even larger deficits and debt levels.

Worse yet, what happens when investors demand higher interest rates? As mentioned above, Belgium is already paying an extra 0.4% interest on its debt. That does not sound like much, but with government debt at 100% of GDP, the deficit increases by 0.4% just from the interest payment. This is an additional cost on government at a time when it needs to reduce its costs. It increases the deficit just as the country is trying to reduce it. Furthermore, this creates a self-fulfilling prophecy: worries of a debt crisis will cause a country’s interest payment to rise and deficit to increase, thus increasing the chances of a crisis.

So I will repeat what I’ve written many times: The sovereign debt crisis is far from over. In fact, it is just beginning.