Ireland enjoys market support
Ireland's CDS spreads hit 138bps on Friday, their tightest level for more than three years, an apparent market endorsement of the government's economic policies.
The EU certainly regards Ireland as a model for other countries struggling to escape from debt crises. Ireland has implemented austerity measures with alacrity and with relatively little complaint from its suffering citizens.
Exports have boomed and the country now has a current account surplus of 6.1% of gross national product. The economy is growing, albeit weakly, and the government has successfully issued debt in the capital markets.
Ireland is due to exit its bailout programme later this year and it seems to be in good shape to finance itself independently.
However, this masks inherent weaknesses in the Irish economic model. The country is heavily dependent on foreign multinationals, which make up the bulk of its exports. Profits are repatriated abroad, meaning that gross domestic product is a misleading measure of economic size.
GNP is a more accurate measure, and in Ireland's case it is significantly smaller than GDP. And to make matters worse, GNP is inflated by companies that move their domiciles to Ireland for tax reasons, but don't have real operations within the country.
Ireland's current account surplus would be far lower if repatriated profits are stripped out, and its general government debt is still at an eye-watering 145% of GNP. The country's budget deficit is projected by the IMF to be 7.5% of GDP this year, one of the highest in the EU.
Unemployment is stubbornly high at 14% and the parlous state of the banks and a 50% drop in house prices mean that consumption will remain low.
So, Ireland has made progress, but it is far from clear that austerity has been the unqualified success that the EU would like it to be. Does that mean the sovereign's CDS spreads could widen sharply again? Perhaps, but while the ECB is standing ready with the Outright Monetary Transactions Programme and other central banks are pumping enormous amounts of liquidity into the financial system, at this stage it is hard to see a significant reversal.
The direction of monetary policy will continue to be the main driver of overall spread direction in the coming weeks, with the markets sensitive to hawkish comments from Federal Reserve officials.
Spread performance this week suggests that the consensus is that central banks are nowhere near withdrawing support - the Markit iTraxx Europe ended the week at 91.5bps, close to the 89.5bps tight level reached on May 7. A major negative catalyst will be needed to shift the index decisively out of its current trading range.