So You’re Saying There’s a Plan?
BBH CurrencyView
- Market confidence continues to improve amid hopes that euro zone policy makers take bold actions
- Slovenia begins vote on EFSF ratification; sharp shifts in positioning may prompt mean reversion
- Hong Kong’s trade figures showed a softening of exports; Brazil loan growth focus in LATAM
Risk appetite continues to recover off the back of hopes that euro zone policy makers will soon begin to take bold measures to get ahead of the sovereign debt crisis. Stock markets have continued to rally, and the pan-Euro Stoxx 600 is now up for a third straight day and up over 5% since Friday’s 26-month low. Asian stocks rallied strongly, too, with South Korea up over 5% and Japan and many others of the region’s indexes closing around 3% for the better. S&P 500 index futures indicate a 1.1% gain. Driving the market is optimism that there will be an extension and leveraging of the EFSF in the euro zone and a recapitalization of banks to prepare the ground for a bigger than envisaged Greek default. Elsewhere, the drop in UK’s CBI trade headline adds to speculation of further BoE QE.
In the G10 today markets are likely to remain focused on the policy outlook in Europe, with Slovenia slated to vote on the EFSF changes agreed upon at the July 21 meeting. We think it is likely that Slovenia passes the measures, despite the fact that the center-left government lost parliamentary support last week. This vote is followed up by Finland tomorrow and more importantly by Germany on Thursday. The potential for ratification of the measures designed to enhance the EFSF that were agreed upon July 21, along with news that Greece continues to pledge commitments to budget consolidation are supporting risk appetite. And while we think the euro is likely to benefit from good news relating to the enhancements of the EFSF and the potential for the necessary budget consolidation in Greece, we think in part that any moves in the euro and other growth sensitive currencies over the coming days are likely to be a function of market positioning and short-covering, rather that fresh longs. In fact, according to the most recent reports on speculative currency positioning from the CFTC, the market is now officially short euro’s to the tune of nearly $14bln, indicating a nearly one standard move in euro positioning over the past month. What’s more, this has led to a cumulative shift of nearly $16bln in euro contracts over the past two months and an unprecedented shift in risk reversals. This type of shift is consistent among many of the growth sensitive currencies, the dollar bloc in particular, with AUD exposure being cut by nearly $6bln and CAD by $3bln. On a relative basis sterling has been under more pressure recently, with the shift in contracts leading to a 1.5 standard move in positioning and currently a net short position of nearly $6bln. Altogether, this indicates that the intensification of the euro zone debt crisis has led sharp shift in sentiment of high-beta currencies that were linked to equities and global growth, while exposure to the sterling and euro were cut due to idiosyncratic issues, relating to the growth and monetary policy outlook in those countries that is likely to remain headwinds over the medium term.
In the EMs space there is not a great deal of data that is likely to drive markets either way but we continue to expect that EM is likely to rally with positive headlines in Europe, which is likely to boost sentiment, in addition to stocks. In Asia, though, Hong Kong’s August trade figures were released, with exports coming in a bit softer than expected at 6.8% y/y versus the consensus of 7.5% y/y. Of note, exports to China slowed to 3.4% y/y compared to previous 4.8% y/y, while exports to Japan and Germany snapped back, with exports to both countries increasing at a double digit pace year-over-year. As a result, the trade deficit narrowed slights to HKD34.8bln. And while the weakness in the headlines may in part be driven by the high base, this report suggests that for the most part demand from Hong Kong’s trading partners is indeed slowing, especially the US. Nevertheless, growth in Asia still remains relatively strong and intra-regional trade is likely to offset some of the weakness from some of Hong Kong’s Western trade partners. But the combination of an intensification of the euro zone crisis, which may in time lead to a recession, and the potential for further weak macro data from the US would highlight the fact that Asia is not immune from a slowdown in the developed world. In LATAM, Brazil August loans will be released at 3pm EST. Markets will be looking for any signs of faster loan activity. In light of the August 31 surprise rate cut, August may show some slowing before September numbers pick up. Our bottom line is that domestic economic activity remains strong, and that the 50bps cut was not needed. And yet since Friday the market has been increasing the odds of a move in October. In fact, next policy meeting is October 18/19 and markets are looking for another 50bps cut, which will add to price pressures.
I doubt that the Euro plan to save Greece will actually work. A 50% haircut might sound generous but it will still mean that Greece will have a deficit and a debt burden that will drag its economy down. It will only be a matter of months before another default is on the cards. Even a 100% default and exit from the eurozone will be painful. I can see mass migration from Greece and tensions in the Balkans.
Then the transfer of junk bonds at par to the ECB in exchange for cash will mean that the ECB’s balance sheet becomes highly toxic. That is a massive potential for fraud when banks offload all their bad loans on the ECB. Then what we get is a ECB with 2 trillion of bad possibly worthless assets.
A better solution would be to allow Greece to default entirely. Force banks to take their losses. If the banks are wiped out then they will be nationalised forcing bond to take haircuts and wiping out shareholders. Then using some of the rescue fund to re-capitalise the newly capitalised banks. Then using the balance of the €2 trillion to actually have public works programs across Europe where jobs are actually needed. That will be far better in terms of stimulating the economy and will force creditors to take the pain in this downturn. Saving the banks does not mean saving the creditors.