Greece had reached an agreement on Sunday with the International Monetary Fund and the European Union on a long-delayed rescue package that is worth 110 billion-euro ($146 billion). The aid comes to the debt-heavy country to prevent default and contagion from spreading into other peripheral countries within the Euro-Zone. 80 billion euro will come from the 15 Euro-zone countries while the remainder from the IMF.
With their bailout, I am sure the mainstream media will signal that the coast is clear. Equities, resume your rally. Soon after, I expect to see milk and honey falling from the skies.
Seriously speaking, a relief-rally is plausible, in particular bonds on the short end of the curve when trading resumes. With the escalation of the crisis, the Greek yield curve became inverted signaling its immediate funding problems. The 2-Year spiked 615 basis points over the past three months while the yield on the 10-Year increased to just under 9.00 percent, a rise of 225 basis points.
However, the rally if it happens could be short-lived.
As conditions of the package, Greece agreed to massive austerity measures that have been heavily opposed by the unions. Despite the aid, there are concerns that the will of the Greek government to enforce these demanding measures may collapse due to opposition and continued social unrest.
On Saturday, street protests turned violent on Saturday as 15,000 demonstrators marched through Athens. In an effort to cut its budget deficit to within safe levels of the EU’s guidelines, Greece plans to cut public sector employee wages and freeze pensions. Furthermore, the country is expecting to raise its value-added tax as well as plans to increases taxes on fuel, tobacco, and alcohol. Also, Greece plans to implement new taxes on properties and gaming, all of which will curb future economic activity. In addition to cutting the budget deficit, Greece expects to be in a recession for the next 2 years before returning to growth in 2012 supposedly.
This solves the crisis for now but this is nothing more than another “kick the can down the road” move, which is a common theme these days practiced by developed countries. This crisis stems from the fact that due to its membership in the EU, Greece cannot devalue their currency. Their lack of ability to do so, resulted in Greece’s uncompetitiveness in the global marketplace which in turn, led to the need for excessive borrowing and leverage to prop up economic activity.
Going forward and with their currency stuck, prices and wages need to decline significantly to increase demand and export income. Failure to cut costs will ultimately result in more job losses and higher unemployment, which further curtails growth. Add the impending higher taxes, hopes of returning to growth in 2012 may be nothing more than a pipe dream. The market may see this and the noose around Greece’s neck as well as the other peripheral economies, may eventually start to tighten. Stay tuned.