The Long Shadow of Greece's Woes

As it is becoming increasingly evident this week, the fiscal crisis in Greece can have repercussions that far exceed the confines of that country or the so-called bloc of PIIGS within the Eurozone. The renewed blow-out of Greece's borrowing spreads highlights how difficult the road to a relative containment of that country's fiscal troubles will be and it appears that the entire affair is steadily marching toward a major, IMF-led, bailout to the tune of 30 to 40 billion euros.

In the meantime, the spike of the Greek spreads are already taking a toll on Eurozone stock markets, as shares of European banks are taking a particularly hard hit. Protracted anxiety over the outcome of the Greek debt problem can cause a more substantive setback to the prospects of an already fragile economic recovery in the Eurozone countries via weaker stock prices and household wealth formation and also by exposing more fault lines in the banking system on the continent; in regards to the latter, it is, after all, German and French banks that are holding the lion's share of the repeatedly downgraded Greek sovereign debt.

U.S. equities, despite their impressive rally in the last year or so (buoyed by the reality of an economic recovery gaining traction) may not remain totally immune to any significant downturn of European equity markets under a scenario where Greece remains on the brink for an extended period. Such an outcome may take some of the tailwind out of the sails of the U.S economic recovery, as, given the still high level of unemployment, consumer spending would need to rely more on the net wealth effect from equities in the months ahead.

The Greek affair is also complicating the ECB's exit strategy, as any outright tightening that the famously hawkish ECB might be contemplating for later in the year could become a highly destabilizing factor for the entire Eurozone recovery. The ECB has already been forced, as a direct gesture to the Greek debt crisis, to announce that it will continue accepting less than top-rated collateral for its open-market operations beyond the end of the year, reversing a previous decision to end that special liquidity program by December.

The flare-up of anxiety created by the blow-out of Greek spreads this week has also been a key factor -along with the unmistakably reassuring comments by Bernanke yesterday- contributing to two healthy auctions so far this week and the quick retreat of Treasury yields, following the initial sell off that followed last Friday's employment report. Yields across the maturity spectrum have now pulled back by as much as 15 basis points, returning essentially to pre-employment report levels.

All in all, the long shadow that the Greek saga is casting should be viewed as a reminder that global financial markets are indeed far more interconnected than often realized. The message for the U.S. treasury market, in particular, perhaps can be simply summarized as follows: It is no longer just about nonfarm payrolls, or economic data...

Anthony Karydakis