S&P reckons 50-70% haircut for Greek debt restructuring, weakening euro

BBH CurrencyView

• US dollar mostly stronger on the day, CHF and JPY being exceptions.
• Euro periphery concerns resurface, weakening euro
• EM Asia news positive, Singapore moves trading band upward

The dollar is mostly firmer against the majors with the renewed concerns over Greek and Irish debt restructuring taking the euro off its recent highs. The re-emergence of euro zone fiscal woes prompted the euro to fall while sterling is supported in part by strong consumer confidence. Against this backdrop, the dollar hit fresh lows against the CHF and JPY. European equity markets have succumbed to selling pressure following a mixed Asian session, with the Euro Stoxx 600 down 0.6%, while commodities are trading on the back foot as well. US stock futures are likewise down 0.5%. The downbeat mood prompted a flight to quality with sovereign bond yields down, while eurozone peripheral bonds showed renewed stress with Greece’s 10-year yield reaching 13%.

The euro zone periphery debt market has moved back into the fore, with Greece taking center stage again. While additional news flow out of the Ireland indicates that the Irish government is now considering the term “structured default” as a crisis solution, the news flow has done its part to prompt a rise in the peripheral debt risk premium and in turn take the euro down from its recent high. Greek yields have been flaring up in the past couple of days amid concerns over the possibility of restructuring as a final end game but today concerns were amplified as the German finance minister and S&P both suggested that the risk of Greek debt restructuring has risen and may indeed be the most likely outcome. S&P, for example, envisions a 50-70% haircut with a 1-in-3 chance of default. Greece’s 10-year spread to Germany has reached euro-era record. As such, Germany’s readiness to discuss Greek debt restructuring has prompted hedgers to embrace the worst with the 5Y CDS spread hitting fresh highs. What can we deduce from the 5-year CDS market? Greece’s 5-year CDS is currently trading at 1107bps, which in fact, implies nearly 60% chance of default, while Portugal and Ireland’s current price indicates roughly a 40% chance of default in five years. On the other hand, despite the spread of contagion the outlook for Spain is more sanguine. According to the 5-year CDS contract, Spain’s 5-year CDS price is currently pricing in only a 17% chance of default, which at these levels is more of a tail risk than the most likely scenario. Therefore, the recent price action and growing signs that long-EUR positions are getting stretched may be a sign of consolidation ahead of the recent highs but with Spain’s problems likely to be contained and the Fed on hold, the risks for the euro remain to the upside. 1.4330 should offer support on the downside, and barring a significant change in Spain’s outlook, an upside break of the 1.458 level would be a full retracement of the January 2010 move and likely lead the euro to retest December 2009 high near 1.465.

News from EM Asia reflects the continuing strength of those economies. A day after Singapore reported 23.5% annualized growth in Q1, the Monetary Authority of Singapore re-centered the SGD trading band upwards, both to curb inflation and to keep a lid on the economy. MAS uses the exchange rate rather than interest rates to control monetary conditions. The MAS move has no implications for the rest of Asia. There is no monetary coordination in Asia, with most policy-makers running mercantilist-type policies that favor their own exports via undervalued exchange rates. Rather, Singapore is simply one of many central banks in the region that are tightening in a unilateral manner. China announced that FX reserves topped $3 trillion for the first time, up $53 billion for March, and new bank loan growth came in stronger than expected as well. We see the outcome of all of the recent positive Chinese data being that China will continue tightening at their gradual pace using a combination of reserve requirements, interest rates, loan quotas and FX appreciation. We maintain our base case of a soft landing and don’t see Chinese tightening as rattling global markets. Japanese data showed that for the week through April 8 Japanese made a small net investment in overseas securities, while foreign investors purchased a net $17 billion in Japanese securities, mostly short-term. The yen has continued strong today, approaching USD/JPY 83.00 and breaking below EUR/JPY 120 on a bit of a safe haven bid today, as well as a continued retracing of some of the large weakening yen move from the intervention through last week. USD/JPY should find support from moving averages between 82.75 and 83 the figure.