Regling and Merkel Comments Help Support The Euro

BBH CurrencyView

• US dollar is broadly weaker as market sentiment builds on yesterday’s improvement
• Official and unofficial views on Greece are not in short supply, but vary across a wide range
• Germany may be stepping back from restructuring talk regarding Greece

No news is good news for Greece and the markets, it would seem. With no major tape bombs today, risk appetite and the euro remained supported during the London morning, helped by news that Asian investors and governments, including China, will support EFSF auctions associated with Portugal’s bailout. The dollar is broadly weaker against other major currencies, especially NZD rising 1.3%, but also against SEK, AUD, NOK and EUR, all rising between 0.5 and 0.8%. The outperformance of the NZD followed reports that China’s sovereign wealth fund was ready to invest NZD6 bln in the country, driving NZD/USD to 0.8100, close to the February 2008 high of 0.8179. Periphery sovereign debt yields are mixed. In the 2-year sector, yields in Spain are down 8bps, down 5bps in Ireland, flat in Greece and 7bps higher in Portugal. In the 10-year sector, Greek yields are down 15bps to 16.27%, the third consecutive decline totaling about 45bps since Monday’s close. Treasury yields are little changed. European and Asian equity markets are mostly higher, despite news of three explosions near several government buildings in the eastern province of Jiangxi. Chinese stocks ended the session slightly lower. S&P futures are pointing to a small positive open. Commodity prices are slightly lower higher, after two sessions of substantial gains.

There has been no shortage of comments about Greece this week, both official and unofficial, making for choppy, headline-driven trading conditions. Positive sentiment today is being helped by EFSF head Klaus Regling, quoted by the FT saying that Beijing was “clearly interested” in the auctions for the Portuguese bailout bonds. The article also confirmed that China had participated in the January auction to raise funds for Ireland’s bailout. While positive at the margin, these purchases would do little to address the more important liquidity and solvency concerns of periphery debt. In fact, the inability of the EFSF to raise funds was never a major concern. The market may be making the logical leap that the news implies a broader support for periphery assets by Asian buyers. We would not assume this is the case, preferring to take the comments at face value. In our view, this does nothing to improve the chances that periphery countries will regain access to primary markets in the foreseeable future.

Change in German stance? That German Chancellor Merkel yesterday ruled out any sort of change in Greece’s debt structure before 2013 could signal a change in stance. Many Germans officials were recently and openly talking about restructuring. Now, perhaps Merkel is clamping down on this with the hopes that taking the Greece restructuring option off the table may reduce market stresses and improve Spain’s chances of dodging the bullet. In other words, back to kicking the can down the road. Recent frank talk about restructuring spooked markets. If the restructuring fears ebb near-term, the can is kicked again, and Spain avoids pressure, then this would be euro-positive.

Some well-known academics are also weighing in. Well-known bear Nouriel Roubini is calling for a Greek debt restructuring immediately, saying there would be limited contagion if maturities are extended and borrowing costs cut. Because principal is preserved, he feels banking sector stresses would be minimal. We wholeheartedly disagree with the notion that a “soft” restructuring will solve Greece’s long-term debt and competitiveness problems. As such, we would never recommend it as a potential solution. We believe that markets would not accept the “soft” option as a solution, and that contagion would continue. Nobel laureate Paul Krugman, on the other hand, sees a 50% chance that Greece will have to exit the euro zone, with “significant” losses seen for holders of Greek debt. This too seems off the mark, as we continue to feel that the costs of exiting the euro currently outweigh the benefits for Greece. While the odds of a Greek exit are no longer insignificant, they are certainly not as high as 50%. However, we do agree that bondholders will eventually have to accept significant haircuts on principal. The only question is when, as European policy-makers continue to try to kick the can down the road until 2013, when the banking sector will be less vulnerable and will hopefully be strong enough to take the hit.

Overall EM sentiment remains one of nervousness, with EM FX bouncing a bit on improved risk appetite. However, we are not convinced that the correction in EM is over yet as it remains very vulnerable to swings in overall market sentiment. EMEA seems most vulnerable right now.