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Is Greece Bracing for Default, EUR Exit?

Last updated 2/6/2012 5:13 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• IS GREECE BRACING FOR DEFAULT, EUR EXIT?
• USD: BRIGHTER OUTLOOK FOR US?
• GBP: WILL THE BOE INCREASE QE?
• AUD: IS THE RBA RATE CUT A DONE DEAL?
• CAD: STRONGER IVEY MASKS UNDERLYING WEAKNESS
• NZD: GOLD AND OIL UNCHANGED
• JPY: NO NEED FOR INTERVENTION NOW

EXPECTATIONS FOR UPCOMING FED MEETINGS

IS GREECE BRACING FOR DEFAULT, EUR EXIT?

The euro may have weakened against the U.S. dollar today, but it ends the North American trading session well off its intraday low of 1.3028. For the time being, the 200 pip range that has confined the currency pair for the past 8 trading days remains intact. Greece failed to reach a deal on its PSI negotiations over the weekend and even though talks are ongoing, at this point, there will either be a last minute rush involving major concessions for both sides or Greece will have to bite the bullet and default. Yet the fact that the EUR/USD is holding near its year to date highs suggests that investors are hoping for an 11th hour deal. Prime Minister Papademos met with ECB, EU and IMF officials (the Trioka) today to try to reach an agreement on austerity measures. He will then take the proposal to the meeting with party leaders tomorrow and if we are very lucky, he will convince them to approve the tough but necessary reductions in spending. At the same, he is planning for the worst - Papademos asked the Finance Ministry to prepare a report on the consequences and implications of a default and exit from the Eurozone. In our opinion, a euro exit would be more detrimental for Greece than for the markets. Consider that the country would have to rush to reintroduce the drachma, it would be an extremely disorganized affair that would involve capital controls and major changes in domestic laws and contracts that would require re-denominating debt obligations in the new currency. Without a doubt borrowing costs for Greece would skyrocket. A Greek Eurozone exit or default would undermine confidence in the euro but with the Greek saga dragging out for months now, investors are getting tired of watching the slow moving train wreck. At this point, many investors have discounted the possibility of a Greek default and for this reason, a default or exit from the Eurozone would not mean the end of the world. Yes, it will be messy and the EUR/USD will probably fall sharply as the focus turns to Portugal, who is widely believed to be the next domino to fall but at least the financial markets will no longer be held hostage by Greece.   With this mind, we are still hopeful that a deal will be reached before the March 20 ^th deadline because no one wants Greece to set a dangerous precedence that could followed by other countries in the coming months. 

In the meantime, with the clock ticking and their backs against the wall, Greece has less than a week to go before their self imposed February 13th deadline to submit a final debt swap offer to private sector bondholders.  A number of additional steps need to be taken before the bailout funds can be released once a PSI deal is announced which is why just because they need to receive their next tranche of aid by March 20th to avoid default, does not mean they have until March 20th to reach a deal. This is a very busy week for Europe – aside from the Greek Parliament meeting (which will hopefully take place tomorrow), Eurozone Finance Ministers are also expected to discuss the Trioka and IMF reports on Wednesday or Thursday. The European Central Bank has a monetary policy announcement on Thursday and the general hope is that they will provide either verbal or physical support for the region. The market expects the ECB to expand their Long Term Refinance Operation but they may choose to see how the Greek negotiations go first.  If talks are derailed and financial markets react violently, a new LTRO program could go a long way in stabilizing the markets. Meanwhile German factory orders grew 1.7 percent in the month of December. The stronger than expected increase bodes well for tomorrow’s German industrial production report.

USD: BRIGHTER OUTLOOK FOR US?

Since it is quiet week for U.S. economic data, the dollar will predominately trade on risk appetite. Today, U.S. stocks recovered much of its earlier losses to end the day only slightly lower.  At the start of the North American trading session, the dollar strengthened against all of the major currencies but by the day’s end, it was only higher against the euro, Swiss Franc, Canadian Australian and New Zealand dollars. The greenback turned negative against the euro and the Japanese Yen. There was absolutely no U.S. economic data released today, leaving us with nothing but comments from Fed President Bullard, who is not a voting member of the FOMC this year. Bullard is clearly a supporter of the central bank’s recent transparency measures – he believes that the 2 percent inflation target will serve the nation well. Unlike Bernanke who emphasized the significant downside risks, Bullard sees the jobs situation improving by the end of the year. He predicts that the unemployment rate will drop below 8 percent which is far more optimistic than the central bank’s own forecasts which looks for the jobless rate to end the year between 8.2 and 8.5 percent. The IMF’s Chief Economist Olivier Blanchard also appears to share Bullard’s rosier outlook. He said today that recent data in the U.S. and Europe suggests that the IMF may have underestimated growth in these 2 regions. The expansion in the U.S. may be closer to 2 percent than the 1.8 percent estimated while the Eurozone could actually grow slightly this year rather than slow by 0.5 percent as they had initially forecasted. The IBD/TIPP Economic Optimism index and consumer credit are the only pieces of U.S. data scheduled for release on Tuesday. Neither of these reports will have much impact on the U.S. dollar but the IBD index is typically a useful leading indicator for the University of Michigan Consumer Sentiment report set for release later this week.

GBP: WILL THE BOE INCREASE QE?

The British pound extended its gains against the U.S. dollar and euro on the heels of better than expected economic data. House prices rose more than expected in the month of January thanks to low interest rates. The U.K. economy may have contracted in the fourth quarter but prices rose for the first time in 3 months which is yet another sign that the economy may not be doing as poorly in the first quarter as it had in the fourth. In fact, according to a survey conducted by Lloyds Banking Group, Britons felt less concerned about the labor market in January compared to December. Granted, they still remain very pessimistic, but this improvement suggests that the outlook has not worsened. The Bank of England has a monetary policy announcement this week and many economists expect the central bank to increase their asset purchase program by GBP50 billion to GBP325 billion. With all three PMI reports showing expansion in the service, manufacturing and construction sectors, come Thursday, the BoE has 3 options. They can keep their QE program unchanged, which would be positive for sterling. They can raise it by GBP50 billion and say something bullish about the economy which would minimize the downside impact of more QE on the pound or they can raise asset purchases and warn of more to come, which would probably erase a good part of the currency’s recent gains. 

AUD: IS THE RBA RATE CUT A DONE DEAL?

The Reserve Bank of Australia is expected to cut interest rates by a quarter of a percentage point this evening in what would be the country’s third consecutive rate cut. Consumer spending has been very weak with retail sales declining 0.1 percent in December. Excluding the effects of inflation, prices rose by 0.4 percent, but if we take a look at the individual monthly changes in retail sales the last three months of the year, there was virtually no growth. The labor market also deteriorated with 29.3k workers losing their jobs in December. Granted, all of these job losses were part time and full time jobs actually increased by 24.5k, it does not eliminate the fact that more people lost jobs than gained them towards the end of the year. Inflationary pressures have also eased on both the consumer and producer level, giving the central bank room to loosen monetary policy if necessary.  The question then becomes whether more stimulus is necessary.  The RBA has already cut interest rates by 50bp late last year – there are many signs that the economy ended 2011 on a soft note but things appear to be picking up in January. Both the manufacturing and service sectors grew at a faster pace last month while job advertisements jumped the most in 23 months. The mining sector is on a hiring binge which should translate well for the rest of the economy. These signs of improvement will make today’s rate decision a close one for the RBA. Meanwhile the Canadian and New Zealand dollars also weakened against the greenback.  According to the latest PMI report, manufacturing activity in Canada grew at a faster pace last month.  The IVEY PMI index rose to 64.1 from 63.5, the strongest reading since May of last year. Unfortunately the details of the report showed widespread weakness with nearly all of the subcomponents from employment, inventory, supplier delivery and prices growing at a slower pace last month.  At first glance, the IVEY PMI report painted a bright picture for the Canadian economy but the headline number masked underlying weakness.

JPY: NO NEED FOR INTERVENTION NOW

To the delight of the Japanese government, the Yen either held steady or continued to weaken against all of the major currencies. The better than expected U.S. jobs number on Friday eliminated the immediate need for intervention. However we can get a better understanding of why the Japanese have been so resistant to artificially weakening the Yen from Economy Minister Furukawa’s comments. He blames the Yen’s strength on a loss of trust in other currencies which is absolutely true because there is nothing healthy about Japan’s economy.   In this light, they feel that intervention would be futile because the source of the problems abroad have not been resolved. As a result, the only thing they can do aside from hoping for Europe and the U.S. to get their fiscal houses in order, is to increase asset purchases. However, even this program has had a limited impact on the Japanese economy. There are a few pieces of Japanese data scheduled for release this week, but most will not be reported until Wednesday evening in the U.S. / Thursday morning local time.  The coincident index and leading indicators are scheduled for release tomorrow and a minor improvement is expected.

AUD/USD: Currency in Play for Next 24 Hours

AUD/USD will be our currency pair in play this evening with the Reserve Bank of Australia rate decision scheduled for 10:30pm ET / 3:00 GMT.

The AUD/USD has enjoyed a spectacular run since the beginning of the year. Last week, the currency pair climbed to its highest level since August. The 1.08 level, which has capped gains in the currency pair in the past will as resistance. If the AUD/USD manages to gain enough momentum to break above this level, 1.10 will serve as the next area of resistance. Should the RBA announcement trigger a sell-off in the AUD/USD, support will be at 1.0650 the 10day SMA followed by 1.015, the 20-day SMA.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.