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The state of play: PIIGS trouble, round 15
At the beginning of July, the fear of the implication of QE2’s end and the fear generated by the replaying of last year’s bailout crisis in Greece – if with heightened drama – initially yielded to a massive melt-up in risk assets, with the US S&P500, for example rocketing as much as 100 points from its late June lows. AUDUSD rallied 400 pips, EURUSD rallied almost 500 pips, the JPY crumbled as 10-year US treasuries jumped as much as 35 basis points after several weeks of very strong bond markets. But then everything suddenly switched directions, as the hoped for solution to the Greek debacle proved a mirage, followed by a period of uncertainty as EU officialdom scrambled to hold a series of emergency meetings, which have brought yet another round of hope, a cycle that has repeated itself ad nauseum since late 2009. The stakes are higher than ever now that Italian and Spanish debt yields have moved to critical levels.
For the coming month, here are three key themes the market will be grappling with:
- Latest round of EUR crisis demands more credible response – is that what we get?
It’s getting to be either/or time for the Euro Zone. Either the EU/ECB gets its act together and starts talking reality and stopping the serial “extend and pretend” approach to every episode of EuroZone stress or it risks getting behind the market and thus a disorderly outcome to its sovereign debt challenges. After the embarrassing failure of the French approach to rolling over Greece’s debt in July, it appears some measure of the reality of default is on the table for a real Greek debt solution. (Hardly the first or the only to say this, we have long said that Greece will default – it seems the EU is finally figuring this out as well, though as of this writing, the only official move was toward bond buybacks in the secondary market rather than real restructuring. Not much farther down the road, there is a Greek election to consider as well.). The pain the failure of the second Greek bailout attempt is inducing (as the market ponders contagion as other sovereigns may want in on the restructuring action as well eventually) may actually be a strong step toward firmer action rather than continued posturing and non-solutions. But will the EU be able to pull together sufficiently and get ahead of the curve in response to the debt crisis or do we get Lehmanesque systemic risk first? Stay tuned.
- Will the carry trade applecart remain upset?
Our risk measures have been all over the place of late as you can read lower in our monthly Carry Trade article – but mostly they have been down, even if equity indices have not reflected this to a large degree. While the JPY has responded rather strongly to carry trade/risk themes, the USD response has been anaemic relative to cycles past when the greenback seemed more tightly correlated (negatively) with risk. Is this owing to the US impasse on the budget deficit and debt ceiling talks and real concerns of a default, or simply because commodities and equities haven’t correct enough to suggest a sufficiently broad based reason to run to the hills and into the “safer” currencies – or at least, those currencies that have been used to fund purchases of risk assets.
The status of this political “melodrama”, as at least one newspaper put it, change by the day, but it appears some kind of deal will be done very soon, whether it is the “fallback” plan of minimal cuts while raising of the debt ceiling until after the 2012 election, or a short term deal that is tied to a much larger and longer term package down the road that might include tax reform to boost revenues – the situation is very fluid and the particulars seem to change daily.