Over to the Greek Parliament

Although the EU authorities may have made progress on getting Europe’s banking sector, French banks in particular, to voluntarily rollover their holdings of Greek debt, potentially extending its maturity by up to 30 years, Athens fate now rests in its own hands. The first Parliamentary vote is scheduled for today to try and pass austerity measures totalling EUR30bn to ensure the release of the next tranche of bailout funds and avoid default. The result is not expected until 30th June so the markets may tread water until then.

The market is extremely clam in the lead up to this vote although some reports suggest that members of the ruling Pasok party will vote against the Prime Minister’s plan. The government has a slim majority of 155 seats out of 300, so it needs all the votes in can get. We are of the opinion the vote will be passed. The alternative to voting against even more budget cuts and privatizations plans is political suicide. A disorderly default in Greece would plunge the country into the deepest recession in recent memory, would block it from capital markets for generations and would erode living standards even more so than the current fiscal consolidation plans.

Although the euro came off its 1.4330 highs on comments from ECB member Stark that there is only a “plan A” for Greece, suggesting that there is no contingency if Athens fails to pass further austerity measures, it is still trading in a tight range and there has been limited downside for the single currency. This may be because investors are worried about missing a relief rally in the event that the vote passes, but the long-term problems in Europe’s periphery remain as bad as ever with or without this vote. The wrangle over the next tranche of bailout funds is only a tiny step in Greece’s journey to fiscal sustainability, and even if this vote is passed it will require years of austerity measures to get the finances back to a manageably high level.

Bond investors know this, and while the euro remains comfortably above 1.4000 for now, bond yields across Europe are spiking. Italian bond yields have jumped again to above 5 per cent. Europe’s sovereign crisis has turned a very dark corner in recent days as the “core” economies like Italy and France have seen their bonds come under pressure. There is even some concern that Latin America’s banking sector, where large Spanish and Portuguese banks are big players, are at risk if these financial institutions have to repatriate funds home to deal with their own sovereign issues.

This means that we may only be at the beginning of the contagion effects of the Greek debt crisis. Over the past year the larger economies of Europe, although fiscally constrained, have been relatively unscathed, but we may be the on the cusp of a great re-pricing of risk, whereby the notion of sovereign debt being risk free is erased and larger well-respected sovereigns themselves become credit risks. This suggests that higher bond yields for Europe’s largest economies may be here to stay.

However, the sovereign crisis is only one factor weighing on the euro. In the other direction, the European Central Bank is scheduled to hike interest rates next week for the second time since April; the only major central bank to start normalising rates so far. So the yield effect is still on the euro’s side for now.

Elsewhere, the pound is getting hit after a downward revision to the GDP figure for the first quarter. The year-on-year rate fell to 1.6 per cent from 1.8 per cent. This was not expected by the market and the fall in growth was due to trade data being revised lower and weak consumption data as household incomes get squeezed by higher inflation. This increases the chances of further QE, after the latest BOE minutes suggested that some members are already considering whether the economy may need further stimulus going forward. On balance this is sterling negative in our view, and we would look for GBPUSD to fall towards 1.5500, especially if more QE seems likely just as the Federal Reserve comes to the end of its second round of stimulus.

Bank of England members King, Dale, Tucker and Miles have been testifying in front of the Treasury this morning. So far the comments have mostly centred on high inflation, however, noted dove Miles said that there was little sign that long-term inflation expectations were becoming de-anchored from the 2 per cent target rate paving the way for more stimulus. Sop going forward BOE meetings might be more of an event risk if we see economic data continue to take a turn for the worse.

In this environment the dollar and the Swissie are likely to perform well. As we said above, even if today’s vote in Greece passes it won’t ease long-term concerns about Europe’s sovereign debt. Also, as the spotlight focuses more on the core economies the outcome will not be pretty for risky assets. But in the short-term, risk may stage a brief relief rally if the vote in Athens passes, but any blockage would dent investor sentiment and could see EURUSD tumble below 1.4000.

Source: Forex.com

28.06.2011