August 15, 2022

Fundamentally: The Markets and Greece: Variations on a Theme

HOW worried are investors about Greece’s financial mess? Could it take a huge toll on Europe and upend the global recovery? A standard way to answer such questions is to turn to the financial markets, which are often thought to reflect and foreshadow the underlying health of the economy.

Yet in recent weeks, the stock, bond and currency markets have seemed to be painting different pictures about the severity of the threat.

Until last week, bond market investors were racing feverishly into 10-year Treasuries amid growing signs that Greece was on the brink of defaulting on its debt. The market calmed down last week, though, upon learning that the Greek government had agreed to make sharp spending cuts and would be receiving billions in debt relief from Europe.

Even with this news, though, yields on those Treasuries have still fallen from 3.62 percent in April to 3.20 percent now — not far from where rates were in the depths of the financial crisis in late 2008.

In the stock market, investors have responded more quietly. Although the Standard Poor’s 500-stock index had been slumping for more than two months, stock prices recovered last week, and the S. P. is now down only around 2 percent from its April peak.

And currency markets haven’t panicked at all. More than a year ago, when Greece’s fiscal troubles first hit the headlines, the euro plummeted nearly 20 percent against the dollar. This time around, though, the euro has dropped only around 2 percent.

These messages may seem confusing. But upon further examination, all of these markets are probably pointing to the same thing, said Michael J. Cuggino, manager of the Permanent Portfolio, a mutual fund that invests in stocks, bonds, currencies and alternative assets.

Mr. Cuggino summarizes the global outlook this way: “It’s unmistakable that the economy is slowing, but it won’t be a material slowdown, and growth will probably resume in the second half of the year.”

Consider the bond market. While it’s true that Treasury yields nearly sank to November 2008 levels, the reason may not be all that ominous. “In terms of depth and breadth, there are really just two big buckets of government bonds in the world — Treasuries and European bonds,” said Carl P. Kaufman, co-manager of the Osterweis Strategic Income fund. To some extent, what we have seen is “a flight to safety from one bucket to the other,” he said.

Mr. Kaufman noted that until last week, the flow of money from European bonds to Treasuries had been especially pronounced among shorter-term securities. As much as yields on 10-year Treasuries fell, he noted that rates on two-year notes fell faster, dropping as low as 0.35 percent, from 0.85 percent in April. That’s mainly because investors fleeing the European market were “simply looking for a short-term place to park their cash,” he said.

But those yields reversed course last week; the two-year yield is now at 0.49 percent, and the so-called yield curve — a term that describes the spectrum or interest rates paid out by bonds of varying maturities — had steepened slightly. “Historically, steep yield curves signal recoveries,” Mr. Kaufman said.

George Strickland, a portfolio manager and managing director at Thornburg Investment Management in Santa Fe, N.M., agrees. “I’d be much more concerned if the yield curve had flattened — that would be a very bearish signal for all risk markets.”

He said that while Treasury yields did fall to near financial-crisis levels, the credit markets haven’t been experiencing the liquidity problems of a few years ago. For instance, he said, companies are not having problems rolling over commercial paper, a form of short-term debt that companies use to fund their basic obligations.

How should we interpret the relative stability in the currency market?

David C. Wright , managing director of Sierra Investment Management in Santa Monica, Calif., said that “it’s been somewhat surprising that we haven’t seen more stress on the euro.” But we’re still in the early stages of the crisis, he said. And market strategists say that other factors are probably also at work.

Harry W. Hartford, president of Causeway Capital Management in Los Angeles, recalled that when the euro plunged a year ago, there were concerns about whether a common currency could be sustained. Such fears put even more pressure on the euro. But this time around, the currency’s relative stability probably reflects confidence “that the euro will be sustained by policy makers and politicians,” he said.

Mr. Hartford added that the more muted reaction in currency markets might reflect the view that because Greece accounts for only around 2.5 percent of the euro zone’s gross domestic product, its troubles can be contained. “In the grand scheme of things, assuming this crisis doesn’t spread, it’s not a massive issue,” he said.

Of course, if it does spread — to Ireland and Portugal and beyond — all bets on the euro are off. And the debate about the health of the recovery will start anew.

Paul J. Lim is a senior editor at Money magazine. E-mail:

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