Only a few days ago nobody was looking at Europe, despite the many challenges faced by the euro area this year. All eyes were on Trump, the US dollar fell after negligible comments made by the president and his staff of economic advisers. What a difference a weekend makes! It's Tuesday, the EUR is weakening for a second day in a row and miraculously the whole narrative by market watchers has changed. Analysts are highlighting the risk from European election outcomes that might endanger the euro zone, possibly even the European Union. It is as if market commentators woke up and, in unison, had the same thought: Anxiety now! The switch has been flicked, USD risk-off has been turned into EUR risk-off. It's a new week, so let's have a new story to tell. To be frank, I'm fed up with researchers and self-proclaimed journalists (who are doing a lot of things these days, but definitely not serious journalism) wanting to explain to me why an asset has moved in a certain direction after the fact. Instead, they should be separating the important news from all the noise (mostly coming from Trump these days), study the evidence revealed by their research and then make appropriate deductions about the state of the market as well as implications this might have for the future. Too often analysts change their opinion even after minuscule changes in asset prices, instead of showing any sign of confidence in their own research. How can this type of market analysis be taken seriously? Don't even get me started on journalism... The Economist aside, there's little I can read nowadays without having a total freak-out. Anyway, let's not digress: I'm standing firmly by my EUR short / USD long call.
Open positions as of 07/02/2017 08:56am CET:
EURTRY short from 4.0524, unrealized return: +2.75%
EURUSD short from 1.0795, unrealized return: +1.05%
Realized YTD return: +0.7% from 2 trades
Total YTD return: +4.5% from 4 trades
Stock markets in many parts of the world closed higher on semi-positive news from the US labour market yesterday. However, the rise in stock prices over the past few days does not signal the beginning of a recovery at all. I have no doubt that stocks will plummet again in the short run. The downgrades of Italy (Moody's, Fitch) and Spain (Fitch), the dismal situation of several European banks (most prominently, Société Générale and Dexia) as well as the ongoing foot-dragging of the ECB and European politicians all add up to what I consider a pivotal moment in the short history of the euro zone. As Robert J. Shapiro, an adviser to the IMF, and Gerhard Bläske of the German financial newspaper Börsen-Zeitung ("Flächenbrand verhindern", 06/10/2011) recently put it, the euro zone is at the risk of finally breaking apart, if no solution will be found in the nearest future. The AAA rating of France is already being reviewed by many, and it is not impossible that Germany's rating will come under fire, too, when ever more money will be spent on bailing out European banks and sovereigns.
How did we get here? In June, I wrote in the comments to an article that Greece should be allowed to default on its debt in an orderly way or otherwise the can, which politicians and central bankers had already been kicking down the road for much too long at that time, would get heavier by the day. Well, it certainly is heavier now. I understand that the ECB wants to buy time for the government officials to find a way out of their countries' miserable situations by purchasing ever more sovereign bonds. But that's all it is: Buying time. It has been clear from the beginning of the debt crisis that simply pumping money into the markets would not be a solution to the problem. Unfortunately, not much has happened since then. Instead, we had to learn that the stress tests conducted to test the soundness of Europe's banks failed: Dexia performed very well on the test, but in reality it will have to be bailed out now. As a result, France and Belgium will have to provide financial guarantees for tens of billions of euros, which comes with a risk that rating agencies will be taking into account. We will probably know more after the weekend. I am afraid, however, that too much time has gone by and that decisions will have to be made very quickly now, not leaving enough time for a thorough analysis of both the old and new problems Europe is having.
As Greek unions continue their 48-hour general strike before the vote by lawmakers on the proposed five-year austerity plan on Wednesday, markets have been slightly optimistic today. Given that European stock indices are up today (with banking stocks particularly strong), Greek 10yr bond yields are at a three-week low and CDS spreads have tightened, it looks as if the market is quietly betting on Greece's Prime Minister George Papandreou to gain lawmakers' support in tomorrow's vote. The decision on whether or not to pass Papandreou's €28bn austerity measures is a crucial one that will likely have a significant impact on the financial markets, considering that a failure to pass the plan could result in the euro area's first sovereign default. After all, Greece will only receive the fifth €12bn installment of the €110bn bailout from the EU and the IMF if its parliament will vote in favor of Papandreou's plan. The tranche will ensure that Greece will be able to pay creditors through mid July. After that, the country will be dependent on a new EU/IMF bailout package believed to be worth €120bn that, too, is conditional on the passage of the austerity program and the laws needed for its implementation.
Meanwhile, European banks are discussing ways of contributing to this second rescue package for Greece. French institutions announced they would be willing to roll over 70% of their Greek debt maturing between 2011 and 2014. Apparently, 50% of the proceeds from those bonds would be reinvested in new 30-year bonds with the remaining 20% to be invested in zero-coupon AAA bonds with deferred interest. It is possible that the new bonds will be placed in a special purpose vehicle (SPV) backed by the European Financial Stability Facility (EFSF) so they won't show up in the banks' balance sheets anymore. According to Deutsche Bank's Josef Ackermann, German banks are looking into the French model as well as other possiblities, too. Although it was Germany's Angela Merkel who first proposed a private sector participation, again it is Nicolas Sarkozy who seems to be getting things done. Mrs Merkel continues to appear indecisive when it comes to actually closing deals instead of merely coming up with possible strategies. Anyway, France has a special interest in Greece not defaulting on its debt, because French banks have the biggest exposure to Greek debt with €65bn in liabilities. Next in line is Greece itself with around €59bn, followed by Germany (€40bn) and the UK (€19bn). The ECB remains the largest single creditor with €49bn worth of Greek bonds on its balance sheet.
The private sector's search for a good strategy for helping with the rescue of Greece is also made difficult by the fact that rating agencies could classify such an undertaking as a default event, depending on how it were to be executed. Fitch already said it was likely that the company would cut Greece to default if the EU were to go through with its plan to have private investors roll over their Greek debt. In any case, it is very important that the Greek parliament will back its Prime Minister on Wednesday. This will send positive signals to investors worldwide. I am not sure anymore whether Greece can be saved from defaulting, though. It is important for the EU to have a strategy in place for such a scenario. An orderly default of Greece might be unavoidable in the long run if the EU's other member states do not want to throw ever more good money after bad.