European Finance Ministers might be running out of time

The emergency meeting of Finance Ministers called for last night ended up yielding nothing of note except for another exceptional meeting on June 19th – the night before the regular monthly finance ministers’ meeting. There was no official statement, which suggests that the ECB- German spat regarding forcible extensions to the maturity of Greek debt held by private bond holders is no closer to being resolved.

It was comments from Luxembourg Fin Min Frieden that caused a real dent to risk sentiment late last night when he said that no decision on a second bailout for Greece along with a resolution on the involvement of private sector bond holders will be taken until next month. Since reports suggest that Greece runs out of money in mid-July the EU authorities’ are in serious danger of running out of time to come up with a solution to the crisis.

There is no plan B for Greece: either the various branches of power in the currency bloc agree to a compromise to fund Greece for the next 3-5 years (possibly to the tune of EUR170bn), which is likely to include some sort of private sector involvement, or Greece faces a disorderly default and havoc ensues in the financial markets.

In the past, investors have given the EU the benefit of the doubt and taken the attitude that they will sort out Greece’s fiscal problems somehow. But with the ECB digging its heels in and Finance Ministers unable to come to a compromise or offer soothing words to the markets, investors are starting to lose patience. So as the EU leaders meeting next week approaches and as the July deadline for Greece’s cash requirement edges nearer, investors are feeling jittery, which has the potential to fuel a larger correction in euro-area asset markets.

Former IMF economist Raghuram Rajan voiced a contrarian view yesterday, when he said that a delay in a resolution to the Greek crisis gives European banks time to reduce their exposure to Greek debt prior to any default and thus reduce their exposure to losses. Thus, Rajan said, the European banking sector could absorb a Greek restructuring better today than it could 6 months ago.

However, this didn’t stop Moody’s, the credit rating agency, from putting three major French banks with Greek exposure on review for a possible credit downgrade. This didn’t help sentiment towards the single currency.

The debate seems to be settling along these lines: Greece will have to restructure at some stage. Both the restructuring is ordered, well sign-posted and the market is prepared, thus limiting contagion effects to Portugal, Spain etc., or a default IS caused by a break-down in communication between Germany and the ECB. The market is not expecting the latter so the reaction would be sharp, hitting credit markets in Ireland, Portugal, Spain or even Italy and potentially sparking a broader bout of risk aversion.

So the next few days are crucial for the euro in our opinion. There was one positive note this morning regarding economic data. Industrial production data for April was stronger than expected, rising 0.2 per cent on the month; bringing the annual growth rate to a healthy 5.2 per cent. This is positive news for Q2 growth in the currency bloc. Although growth is mostly centred in Europe’s core economies there was good news for Ireland where industrial production in April outpaced that of the Eurozone, growing by 1.4 per cent. This is positive for the financially stricken nation and it suggest that Ireland’s growth profile is looking healthier than that of Greece and Portugal for the second quarter.

While EURUSD tries to cling on to 1.4300 after Portugal had a successful bond auction this morning, the pound looks like it has given up trying to stay above 1.6300 versus the greenback. Employment data in the UK was mixed for the UK. The unemployment rate remained stable at 7.7 per cent, but jobless claims rose by 19.6k in May, far higher than the 6.5k expected. But then the International Labour Organization said that unemployment fell by 88k in the three months to April – the largest drop since 2000. However, the market has dumped the pound as this data, especially weak wage growth, which is now deep in negative territory with CPI running at 4.5 per cent – reinforces the dovish stance at the BOE and suggests that rates will not be normalised any time soon.

The pound is also getting hit as investors avoid risky assets. We expect it to follow the direction of the euro for the coming days until we know more about the final solution to Greece’s debt crisis.

Elsewhere, gold is weaker as the dollar recovers. The sharp move higher in the greenback has followed US bond yields. 10-year Treasury yields have jumped above 3 per cent, after retail sales data for May was not as bad as some thought.

The Aussie is coming off its high after more-hawkish-than expected comments from RBA Governor Stevens gave it a boost overnight. But overall, assets are following traditional patterns with a strong dollar weighing on commodities and stocks and the euro pulling risky currencies lower. This afternoon’s CPI data in the US could cause some volatility. If inflation is weaker than expected the dollar may lose some support.

Source: Forex.com

15.06.2011