Here I used the GSCI Index instead of oil, but only because it has a better history on Bloomberg. If you are a euro bear, by definition you should be an oil bear. Because if oil goes up, where are those countries going to diversify there reserves? Since inception, the answer has always been the euro. No other currency is liquid enough at this time.
The news is full of headlines about Greece’s bail-out. Many terms of the deal exceed expectations. Most of the surprise is positive:
– The news that there will be permanent EU monitors in Greece is a strong positive.
– It is positive that the funding will be held in escrow until Greece has proven its responsibility.
– The fact that rates on official loans will be cut below market levels is a big positive.
– Reports that the ECB will return profits from Greek bond purchases to national central banks, to recycle into the Greek rescue plan is also welcome.
– The only major concern is that private bondholders have been pushed to take further losses on face value, and lower coupon rates. This raises questions as to whether there will be sufficient participation by private bond holders. So, we can understand why Greece legislators are pushing through a collective action clause to force take-up. This increases the chance of the CDS being triggered, but such an event is probably manageable.
At another level, this restructuring agreement represents a massive step forward in financial history, showing the increasing commitment of investors to participate as responsible stakeholders in mutually beneficial economic solutions.
The market reaction is subdued. This is not surprising as the event was largely priced-in. We could argue that these surprise moves are positive on aggregate, but it looks as though the market will unsurprisingly wait for execution. The bond restructuring will be launched very soon, and there are several layers of political approval required before we can say implementation in underway.
For now we would argue this is good news, even if there remain substantial long-term execution risks. We are looking for the risk-on rally to resume in the near future.
Markets have eased off this week, a move that was difficult to predict but is hardly a surprise as we are pushing at technical limits and continuing to wait for clarity on Greece.
The recent announcement that Greece voted through the budget cuts necessary to meet the conditions of the troika’s rescue package has not led to a further up-move, and the market’s caution has been reflected by politicians who continue to stall until Greece has honoured the minutiae of the agreement. (Concretely, we are still waiting for Greek political party leaders to sign up.) More importantly, the scale of political resistance on the ground is now so great that it is far from certain that the EU will ever feel sufficiently confident to release new money.
One possible solution will be to put the funds into an escrow account, from which they can be released as milestones are met. It is curious why such an approach was not used in the first place. Greece could have done far more to improve the competitiveness of its economy, notably if the EU had not simply accepted easier to make, but less structurally supportive budget cuts in return for rescue funds.
Other news remains mixed too. Moody’s threat to downgrade the UK is unhelpful, and the data coming out of Japan are concerning, although the Bank of Japan’s decision to target inflation explicitly is good. Selling yen looks like an increasingly one-way trade now, we can only hope that the currency has not done irreparable damage to the economy. If Greece is an issue (GDP €220 bln), the last thing we need is Japan (GDP €5.3 tln) suffering a confidence break.
In the US, retail sales data for January were slightly below expectations, but this is not a huge surprise. The market had become accustomed to better than expected US data, and so upgraded its expectations. The FOMC projections warned that this typical binary risk-on/risk-off mentality was flawed. Sure enough, the data flowing now are not negative, but less aggressively positive. This is a long, slow economic cycle.
Markets remain highly dependent on the situation in Greece, although it is reassuring that the Chinese have backed the euro this week. It increasingly looks as if Europe has reached the end of its tether with Greece, and the global market increasingly believes that the system can sustain an uncontrolled default. The question is whether this threat is enough to motivate sufficient reform in Greece to secure the rescue package on the table, which is far from ideal, but for many people surely better than economic free-fall.
In the end, then, little has changed. If the terms are met the rescue will take place and the markets have the scope to rally. If not, we face the threat of volatility (although likely less than we experienced last year).
We continue to like corporate bond markets, and look to build further equity exposure on pull backs.
After falling last week, markets are up this morning, following news that Greece has approved the budget cuts necessary to get its debt write-down and extended emergency aid from Europe.
Clearly it is good news that the Greek parliament approved this package, but the low level of public support is apparent. Politicians should have more explicitly reminded the public that private lenders are taking a voluntary write-down of unprecedented proportions. Burden-sharing is already happening.
The concern is that political unity is very weak now, and remains a threat. If European politicians are unconvinced that the budget measures have enough support to be sustainable, then they might not release the cash. However, that prospect looks difficult to defend right now.
Midweek, we can currently expect Greek aid to be approved. This should support markets moving up moderately. Beyond Greece, we are watching some key macro data this week:
– European industrial production (Dec),
– US Advance Retail Sales (Jan)
– US Business Inventories (Dec)
– European 4Q11 GDP
– US Empire Manufacturing (Feb)
– US Industrial Production (Jan)
– US Capacity Utilisation (Jan)
– US Housing Starts, Building Permits (Jan)
– US Philadelphia Fed Index (Feb)
For now, I expect the positive trend to continue, but the direction of the markets remains dependent on data being reported and the headlines around Greece.
Notwithstanding our concerns about the increased chances of a technical consolidation or a small correction this week, markets have continued to rise. The primary driver has been expectations of the long-awaited restructuring of Greek debt. Whilst this strong and steady market move is welcome, I am slightly concerned at its failure to consolidate more healthily, after all, as the saying goes: “what goes up also comes down.”
The details of the Greek restructuring have been increasingly leaked to the press over the last few days. We are now expecting old bonds to be exchanged for 30yr bonds with a coupon of around 3.6% plus a GDP enhancement, so there would a bonus pay-off if the Greek economy performs better than currently expected.
At today’s prices, then, it seems that the Greek restructuring should be full expected, and already accounted for in the market. When it is confirmed, markets might either take the chance to consolidate (for example if the impact on Greek banks is extreme), or continue to move up more slowly (the jump we previously expected is now probably in market prices).
The downside risk is that the market will see through the current European rescue steps and not give the economic union the benefit of the doubt. After all, the Euro Summit continued to focus on fiscal measures, which are negative for growth. Also, (bearing in mind all this austerity) it remains uncertain that even the Greek problem has been addressed with this restructuring, since the European loans and ECB holdings will not be restructured alongside private investor exposure.
So, the European problem is far from resolved, but we believe the ECB’s ongoing liquidity campaign serves to reduce the chances of a dramatic collapse of short-term confidence. Hence, we continue to recommend using any declines as a chance to build exposure to risky assets.
In other news, the US Fed has remained a supportive force, which has been welcome news as we receive a mini-flow of less positive data there. Not only has the FOMC extended the period of near-zero interest rates, but in his press conference last week Chairman Ben Bernanke also expressed a readiness to further stimulate the economy unless he sees improvement in growth soon.
Meanwhile, China has reopened cautiously after New Year festivities. Emerging markets are the leading equity group year-to-date (up 11.2% versus 6.1% for Eurostoxx 50 and 4.4% for S&P 500). We remain positive on EM as an asset class, and on China and Brazil in particular. But, global equity markets remain correlated. If Europe or the US consolidates, EM will probably pause too.