Choppy financial waters ahead

24June 2015

HREE recent events, distinct as they may

appear, point to a singular shared risk faced

by the Irish economy, a risk that is only now

being addressed in our policy papers and in

the mainstream media.

First, over the course of May, European ﬁnancial

markets have posted surprising rises in Government

and corporate bond-yields amidst falling liquidity,

widening spreads and increased volatility.

Second, both the IMF and the Irish Government

have recognised a simple fact: once interest rates

revert back to their ‘normal’ path, things will get test-

ing for the Irish economy.

And third, the Irish Government has quietly admit-

ted that the fabled arrears solutions to our household

debt crisis are not working.

Deep below the lazy gaze of Irish analysts, these

risks are connected to the very same source: the mas-

sive debt overhang that sits on the back of our

struggling economy.

Take the ﬁrst set of news. The problem of spiking

yields and blowing up trading platforms in the Euro-

pean bond markets was so pronounced in May, that

the ECB had to rush in with a bold promise to acceler-

ate its quantitative-easing purchases of Government

paper to avoid an even bigger squeeze during the

summer. All in, between January and the end of May,

euro-area government-bond yields rose by some 

basis points, the cost of non-ﬁnancial corporate bor-

rowings rose by around  basis points, and banks’

bond yields were up  basis point. This is against a

background of declining interbank rates (-month

Euribor is down  basis points) and massive buying

up of bonds by the ECB.

In one recent survey completed by Euromoney

before the May bond-market meltdown almost  out

of  institutional investors expressed deep concerns

over evaporating market liquidity (higher costs of ,

and longer time to complete, trades) in the sovereign-

bond markets. In another survey, completed late in

the ﬁrst quarter (Q)  by Bank of America-Mer-

rill Lynch, % of large fund managers said that

European and US stocks and bonds are currently over-

valued – the largest proportion since the survey began

back in .

In the US the current consensus expectation is that

the Federal Reserve will start hiking rates in Q .

In Europe, the same is expected around Q . And

recently, both estimates have been adjusted closer,

despite mixed macroeconomic data coming from the

economies on the ground. If the process of rates nor-

malisation coincides with continued liquidity

problems in the bondmarkets, we may witness both

evaporation of demand for new government debt

issues and a simultaneous increase in the cost of fund-

ing for banks, companies and the Governments alike.

Which brings us to the second point – the role of

interest rates in this economy.

In its recent Stability Programme Update (SPU) ﬁled

with the EU Commission, the Department of Finance

provided a handy estimate of the impact of a % rise

in the ECB key rate. The estimates – done by the ESRI

Ireland is at risk

from higher bond

yields, normalising

(ie rising )

interest rates

and unresolved

household mortgage

arrears

Choppy nancial

waters ahead

Constantin Gurdgiev

OPINION

INTERLOPER