The Immovable Greek Hurdle

For all the compromises and delays on Greece, nothing can stand in the way of the upcoming bond redemption on 20th March which will force events this week on the private sector participation negotiations which started over four months ago.  Thursday evening is the deadline for responses, but reports suggest that take-up has been sluggish. Greece needs to see at least 66% participation, at which point so-called collective action clauses could be activated, imposing the deal on the remainder. If this is level is not achieved, then the whole deal would be off and Greece will face default. We’re likely to get ongoing reports and rumours on this during the week, keeping markets nervous. Furthermore, there are some reports that the troika (ECB, EU, IMF) believes that a third Greek bail-out may be necessary by 2015, because the country will be unable to return to market financing at this point.

Commentary

China eases off the accelerator.  It’s no great surprise to read today that China is reducing its growth target, with a modest cut from 8% to 7.5%.  There were suggestions over the past couple of weeks that this was likely to be the case and it’s totally understandable. China has been suffering from high inflation - with wage inflation in particular taking off - making the country far less competitive than was once the case. Furthermore, China has a long-held ambition to shift the balance of growth away from investment and growth in net exports, more towards domestic consumption.  But that takes time to achieve and is likely to lead to lower growth in the interim. The significance is that those who have relied on China to an ever greater extent in recent years fear the consequences of a less rampant economy.  Stocks in Asia are modestly softer, as is the Korean won and Aussie dollar, but the reaction is understandably modest because the change was expected and in the bigger scheme of things, the adjustment is very modest.

Europe risks are shifting to the political. In a relatively steady Friday, it was notable that the euro was at the lower end of the spectrum when looking at performance against the dollar, having pushed below 1.33 down to 1.3200 area. Just as notable was the resilience of the Aussie for the second day in a row, again relative to the performance of the euro. It is early days, but the price action fits with our suspicion that the bigger risk this time around is that an external carry trade is of greater likelihood than the internal one of December, when a decent proportion of the cash was recycled back into eurozone bond markets, particularly peripheral ones. It’s also of note that the euro was softer as EU leaders met in Brussels, but it would be tenuous to link the two. For once, markets are not placing any great weight of expectation on this meeting given the decisions already taken on Greece ahead of the event, along with the ECB’s actions of this week and the (related) substantial narrowing of bond yields. Once the Greek barriers are surmounted this month, the focus will turn to politics, with elections coming up in both Greece and France. These create considerable strain, given the temptation to solicit votes on an anti-reform agenda. Indeed, we’ve already seen that in France, with the Socialist candidate having already said that he would overturn the increase in the retirement age, pulling it back down again to 60. This is probably the most worrying development of the week on the political front because it underlines the temptations that those courting voters face. For Greece, although assurances have been sought from opposition parties to stick to the current agreements, the timing is not ideal because the next bailout will have been agreed by the time a new government is formed, together with the private sector debt swap. The risks in Europe are turning more political than economic, at least for the coming couple of months.

Brazil’s struggle with the real.  The Brazilian real has been the standout of the majors so far this year, but understandably the authorities are getting uncomfortable with the pace of appreciation seen, especially given the slowing in the domestic economy. The real was up 8.7% vs. the USD in the first two months of the year in spot terms, but the total return was 10.3% once higher interest rates were taken into account. There is once again talk of ‘currency wars’ from Brazil, which has imposed various measures designed to quell currency strength, such as taxing short-term foreign loans, and the finance minister has referred to “perverse” monetary policies of developed nations.  The real has come off its brief push below the 1.70 level on USD/BRL on the back of last week’s announcements. The concerns of the authorities are understandable. After all, the economy recorded zero GDP growth the third quarter of last year, although there have been some better short-term indicators since then. But with global liquidity so ample it may be hard for Brazil to be that successful in its aim of keeping the currency contained. Indeed, with a modest current account deficit, the country still needs to attract foreign capital, which is probably why it backed away from measures measure aimed at foreign direct investment. For the most part, Brazil may just have to live with currency strength that is largely driven by factors beyond its control.

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Simon Smith, Chief Economist
Michael Derks, Chief Strategist
 
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