☀️☕️ Greece: The last PIIGS to fly

📝 Focus

• Greece: The last PIIGS to fly

📊 In the Markets

• Term Premiums Pop

• Japan wants the other kind of inflation

📖 MoneyFitt Explains

🎓 The Euro and the Eurozone crisis

📝 Focus

Greece: The last PIIGS to fly

On Friday, credit rating agency S&P Global lifted Greece’s credit rating from a BB+ junk bond rating to BBB, the lowest level of investment grade, for the first time since the 2010 eurozone crisis🎓 that started with Greece. S&P gave it a stable outlook, citing improving public finances and progress in addressing its fiscal and economic imbalances.

The move is a major boost for the Greek economy, which has been struggling to recover from a deep debt crisis. Countries with a higher risk of defaulting on their debts must pay higher interest rates on their bonds, so Greece's upgrade to investment grade means it will now be able to borrow at lower rates.

The Greece 10Y Government Bond had a 4.381% yield prior to the upgrade. Bonds issued by Italy, another of the PIIGS, also have a BBB rating with a stable outlook and rallied a little on Friday to yield 4.965%, which is higher than Greece’s. (Yields go down when bond prices go up.) On Friday, we wrote about how the yield on 10-year Italian sovereigns hit 5.035%, its highest since 2012, while equivalent German bunds, also denominated in Euros, yield 2.958%.

..... ▷ The eurozone crisis started in 2010 when Greece revealed that its public debt was far higher than previously thought. This led to concerns about the solvency of other eurozone countries with high debt levels, such as Portugal, Ireland, Italy and Spain (the PIIGS) and all but Italy were cut to junk bond status.

..... ▷ Greece was eventually forced to accept a bailout from the European Union and the International Monetary Fund in order to avoid bankruptcy. The bailout came with strict conditions involving a series of austerity measures and reforms to reduce its debt and improve its fiscal position. These measures led to a deep recession and have been painful for many Greeks, but helped restore confidence.

..... ▷ The stock markets of all of the most troubled eurozone countries collapsed during the crisis. The Athens General Index fell by over 86% between 2007 and 2013, while Portugal’s PSI 20 fell by over 73%. Ireland’s ISEQ 20 and Spain’s IBEX 35 also fell by over 60% during the period. The markets have since recovered some of their losses but have not yet returned to pre-crisis levels.

📊 In the Markets

Asia-Pacific markets were all mildly lower on Friday, extending their losses from Thursday’s heavier sell-off. Traders were “risk-off” going into the weekend on US market losses following Federal Reserve Chair Jay Powell’s prepared comments that inflation was still too high (hardly a shock to anyone.)

Powell added that slower economic growth might be the price to pay to bring it into line (again, hard to see how this blindsided anyone who’s been paying attention) and that monetary policy was not yet too tight (okay, hearing it put that way was a bit jarring.)

It got worse in Europe, with the pan-European Stoxx 600 index losing 1.3%, for its fourth down day in a row, to close at its lowest since the start of the year.

And in the US, the S&P 500 and Nasdaq both dropped over 1% with continued concerns over interest rates rising and the Israel-Hamas conflict spreading. Selling hit sectors like technology and financials particularly hard.

Benchmark US 10-year Treasury yields crossing 5% for the first time in 16 years during the week. The surge in long-dated yields has pummelled markets, though profit-taking and safe haven-seeking traders bought US government debt on Friday, bringing the yield on the 10-year Treasury down 0.08 percentage points to 4.91%.

Term Premiums Pop

Fed Chair Jerome Powell had hinted during the week that the surge in long bond yields might reduce the need for additional rate hikes given the impact on financial conditions, echoing some of his Fed colleagues’ recent comments.

This has recently led investors to obsess about the re-emergence of the "term premium" after years of low interest rates following the 2008 financial crisis.

The rising term premium, which can’t be directly observed, is an important part of the recent sell-off in long bonds as it impacts financial conditions and asset prices, potentially doing the job for the Fed as they aim to tame inflation.

The Term Premium - a mini-explainer:

The Treasury bond yield can be broken up into three parts:

- Expectations for the Fed Funds Rate, hence short-term rates,

- A premium for expected inflation,

- The term premium represents the higher return investors require to compensate for taking on interest rate risk by holding longer-term debt but also includes risk preferences and overall views about the economy and global financial conditions.

The FT describes it as the difference in yield between a 10-year Treasury and rolling over the expected one-year rate 10 times over a decade.

Japan wants the other kind of inflation

Traders will be keenly watching the BOJ’s meeting next Tuesday (Halloween) after core inflation came in on Friday at 2.8% for September, below 3% for the first time in over a year but still above the BOJ’s 2% target.

Japan has been struggling with deflation for decades, and the Bank of Japan (BOJ) has been pursuing an aggressive monetary policy to achieve its 2 percent inflation target, so isn’t this good news?

Unfortunately, current inflation is not driven by domestic demand but by external factors such as rising energy and food prices and the depreciation of the Yen. These factors are hurting the purchasing power of consumers and businesses and could undermine Japan's still sluggish economic recovery.

The BOJ has had ultra-low monetary policies since the 1990s, leaving Japan the only major economy to maintain policy through the high global inflation of the last few years. Will they finally ease up… and will an unwinding carry trade lead to a tsunami of Japanese capital now hiding abroad to rush home?

..... ▷ Japan started its ultra-loose monetary policy in the late 1990s to deal with a prolonged post-bubble period of deflation and stagnation.

The Bank of Japan (BOJ) went on to adopt a zero interest rate policy (ZIRP) in 1999 and later introduced the then-revolutionary quantitative easing (QE) in 2001, which involved expanding the monetary base by purchasing government bonds and other assets.

The BOJ ended QE in 2006 but resumed it in 2010 and then launched an even more aggressive version of QE in 2013, known as quantitative and qualitative easing (QQE), which aimed to achieve a 2% inflation target.

In 2016, the BOJ also introduced negative interest rates and the controversial yield curve control (YCC), which set a target for the 10-year government bond yield at around zero.

..... ▷ Some economists argue that these ultra-loose policies have helped Japan avoid a deeper recession, support economic growth, stimulate credit and investment and fight deflationary pressures.

Others claim these policies have distorted market signals, created zombie firms, discouraged structural reforms, eroded fiscal discipline, weakened the yen, reduced bank profitability and harmed savers and pensioners.

Detractors also warn that these policies have created a dependency trap for the BOJ, making it difficult to exit or normalise its monetary stance without causing severe disruptions to the economy and the financial system.

..... ▷ But Japan is still keen to stimulate its economy, leaving fiscal measures the main tools, such as tax cuts, subsidies, and spending on infrastructure and innovation.

The government hopes that these measures will boost growth, create jobs, and raise wages, which in turn will support domestic consumption and inflation.

The government also expects that the stimulus package will help Japan cope with the challenges of a shrinking and ageing population and enhance its competitiveness in the global market.

Opponents warn that if the stimulus package is too large, it could worsen Japan's fiscal situation (already has the highest debt-to-GDP ratio among developed countries) and that Japan should focus more on structural reforms, such as deregulation, labour market flexibility, and social security reform to address its long-term issues.