Danske Daily: Solution to Greek Debt Problems Not Imminent

Eurozone  Finance  Ministers reject offer by  private Greek debt holders of a  4% coupon, but an agreement is likely in the near future.

Unconfirmed reports by Financial Times that Germany is ready to boost the European firewall to EUR750bn .

Rally in risky assets continues ahead of Obama’s State of the Union address and European PMIs expected to show an improvement.

Markets Overnight

The FT reports that Germany is ready to boost the firepower of the European rescue fund to EUR750bn if stricter budget rules are accepted by the eurozone countries. Apparently, Angela Merkel is ready to the let the existing European Financial Stability Fund (EFSF) with EUR250bn continue together with its successor the EUR500bn European Stability Mechanism (ESM).  The softer stance from Germany came after a call from  IMF’s Lagarde earlier in the day that the eurozone  needs a bigger firewall to avoid larger countries like Italy and Spain being forced into a default. However, the FT story is not confirmed officially and according to  Reuters Merkel’s spokesman Stefan Seibert has already denied that such a decision has been taken.

The last couple of days global financial markets have rallied on hopes that a solution to the Greek debt problems was imminent. However, late last night the negotiations came to a halt as the Eurozone Finance Ministers meeting in Brussels rejected the offer made by private bond holders. According to Reuters it is still the coupon on the new longer-dated bonds that separate the two parties. The bondholders demand a coupon of 4%, whereas the Finance Ministers effectively backed the Greece position that a 3.5% coupon is the highest acceptable. However, the disagreement about the coupon is nothing new and we believe EU commissioner Ollie Rehn when he says that he  expects a deal to be struck within days.

Overnight the market also had to digest banking downgrades of French and Italian banks by S&P. However, the downgrades were expected after the sovereign downgrades a few weeks ago and came after a very strong rally  in European banking stocks that pushed European shares to a five-month high. Hopes of a Greek debt deal and reports that France and Germany would loosen Basel III fuelled the rally. The rally in risky assets ran slightlyout of steam in the US session and the major indices ended close to flat. However, the market has continued to rally in Asia with Nikkei up 0.2% this morning. The euro is also well supported just above the 1.30 mark.

Longer-dated US Treasury yields continued to move higher last night and the curve 2y10y steepened again. We continue to see upside for US yields due to a normalization of market pricing given the current strength of the US economy.  Oil prices also rose yesterday after EU ministers agreed to ban Iranian oil into the EU from 1 July. It fuelled fears that Iran would retaliate and close the Strait of Hormuz which is pivotal for the oil market.

Global Daily

Focus today: The most important data releases today are the German, French and Euro area PMIs for January. We expect to see some improvement from low levels in particular in manufacturing, but nothing like the January jump in ZEW expectations. Euro area industrial new orders for November, which are due later this morning, will be much more downbeat with an estimated 2.2% m/m decline. The Economic and Financial Affairs Council (Ecofin) will meet to discuss Hungary’s insufficient measures to correct its excessive deficit, regulation for the over-the-counter derivatives market and economic governance. The need to increase bailout funds is likely to be debated following calls for more funds from IMF’s Christine Lagarde. Late tonight Barack Obama  will deliver the
91st State of the Union Address.

Fixed income markets: If the PMI data come out in line with our expectations,  it will support  our view of a relatively short recession in the eurozone. This should only underpin the current positive risk sentiment, which to a large degree builds on normalization of market prices following the distressed market situation, which built up throughout the fall of 2011 and peaked before the December meeting. The 2-10 spreads continue to widen sharply in a bearish steepening move.

Further, if the ESM complements the EFSF rather than replace it, it should boost bailout funds to around EUR750bn in the eurozone from around EUR500bn – this is positive all else being equal. Even though this amount is still kind of small, it is a step in the right direction. Also, one could argue that the need for boosting these funds is smaller given that the 3y LTROs effectively work as QE.

The Danish Debt Management Office (DMO) is set to auction DGB 2.5'16 and DGB 3'21 today. Bids must be received by 10:15 CET. As usual, the DMO has not published the volume of bonds to be auctioned. DGBs have underperformed swaps and Bunds since the opening of 3.5% 2044,  although DGBs are still trading at unusually expensive levels versus swaps and Bunds.

If issuance continues in 3.5% 2044, we are likely to see more sellers in 3'21. We prefer DGB 2.5% 2016 to DGB 4'15 and DGB 4'17, given the prospect of limited issuance again in 2012.

FX markets: Yesterday the euro continued to recover on a broad base and EUR/USD hit a session high of 1.3051, but has lost slightly overnight, sliding back below 1.30. In our view the market continues to price out the risk of a disorderly Greek default despite an official agreement not having been reached yet. Of course, some of the euro recovery is due to short-covering given that the market is exceptionally short EUR/USD, see e.g. our IMM update published yesterday, but in our view it also reflects a genuine change in the perception of risk related to the debt crisis. We also note that implied volatility has fallen dramatically in the market, with the G7 measure at a level not seen since March 2011 when it dropped to its lowest level since August 2008. The low volatility fuels demand for carry currencies and also the euro in our view. If today’s PMIs show an improvement we expect to see further euro support with the next resistance level seen at 1.3077 - the 3 January 2012 high.

Scandi Daily

Except the auction in the DBG 3’21 today there is little on the agenda in Scandinavia. Note that NOK/SEK has once again moved above 1.15 after a strong rally in NOK. We continue to favour the upside for NOK/SEK ahead of February’s Riksbank meeting and due to the risk of a sudden spike in oil prices derailing risk appetite. In such a scenario long NOK/SEK looks very attractive.