A Weekly Strategy Guide For Forex, Stocks, Commodities, Both Binary Options and Standard Spot Market Traders
Greek Relief & The Default That Dare Not Say Its Name
GREECE RELIEF DOMINATES MARKETS
Nothing else mattered, not inaction on US debt, not universally bad manufacturing data (except for the US) across globe in the UK, China, Japan, EZ, Italy and India. Standard and Poors warned Thursday that Italy faces risk despite passing additional new austerity measures. Here’s a summary of the week.
The only risk off day in Asian and many European markets due to remaining concerns Greece might not pass additional austerity measures needed to get its next tranche of cash from the EU on July 3rd , or if it didn’t, the EU wouldn’t prevent default anyway to prevent a global banking crisis. In our last week’s market review we correctly argued that until preparations are finished to bailout banks and maintain confidence in the banking system when Greece or other PIIGS default, every effort will be make to keep the PIIGS temporarily solvent. Meanwhile US and some European risk asset markets closed higher as this very idea began to take hold.
The basic strategy is still clearly about saving the bondholders and global banking system, not Greece. Pile on more debt on top of the already unmanageable burden, strip Greece of assets that would help it grow, ignore the structural problems like an overly expensive Euro, lax tax collection, and other factors that hinder Greece’s ability to generate real growth.
Tuesday To Saturday
From Tuesday onward it was essentially the same story with minor details. Growing confidence that Greece would not be defaulting in the coming months, whether via passing austerity measures or a rumoured “Plan B” (if the austerity vote failed) to prevent a default and contagion risk. Plan B, if it existed, was not needed. The austerity measures passed, and on Saturday The EZ finance ministers agreed to disburse another 12 bln Euros ($17.4 bln) to Greece, with details of a second aid package to be finalised in mid-September.
Adding to the optimism was the story of steadily growing willingness by French, German, and other large Greek bondholder banks to actually cash only 30% of their maturing bonds in the coming years and accept new Greek bonds, at least 50% of which have 30 year maturities.
THE DEFAULT THAT DARE NOT SAY ITS NAME
The prospect that bondholders might provide “voluntary” relief eased fears that Greece would soon be in trouble again. As of Friday the big missing detail to all this was what real extra benefits the bank bondholders were getting in return that would allow rating agencies, which so far have said nothing against this deal, to consider the arrangement truly voluntary?
Per a businessinsider.com report, Deutsche Bank Strategist Mohit Kumar explained the plan as follows.
Bondholders exchange securities maturing over the next three years for 30 year bonds with a 50:30:20 split where 50% gets rolled into a 30year Greek Government Bond s, 20% is allocated to a fund invested in AAA securities (which? Of Greece?!), and 30% is paid as cash. The coupon on the 30Y GGBs is proposed to be a 5.5%, plus an “uplift” (huh?) depending on the GDP performance (which is supposed to be good???!!). I assume this means they get more if Greece manages to grow under the currently failing formula of yet more debt, growth-stifling austerity, and a fire-sale of valuable national assets that might have helped Greece grow. I see.
“Three issues that need to be considered from a bondholders perspective are the NPV impact, accounting treatment of the rolled over securities and liquidity considerations. The transaction appears to be NPV positive on aggregate for bondholders participating in the roll-over process, which acts as an incentive to encourage a large participation rate.”
Business Insider’s Joe Weisenthal notes:
“Now there are a couple key points here, the first is that there’s some question about whether such a radical restructuring would count as a default. This matters a) for triggering credit default swaps and b) the ECB can’t take Greek debt as collateral when Greece is in default. Well, word is – according to Reuters — that the ratings agencies are actually OK with the plan. This might be stunning, since really, this is a radical restructuring…”
Exactly, and that’s just another way of saying partial default. Weisenthal’s explanation for the silence of the ratings agencies:
“when you have European politicians regularly blasting the ratings agencies, or even talking about coming up with their own homegrown ones, why rock the boat?”
In other words, with enough political pressure, the ratings agencies will fold.
The whole arrangement seems like a farcical ignoring of this default, considering that that this move could cause major losses for investors holding Greek debt at face value to maturity. Also, those who bought default insurance will get neither their bond payments nor their default insurance, but instead 30% cash and 70% dubious Greek paper at 5.5%/year, hardly market rate for a nation still widely believed as likely to default in the coming years.
The rather shaky rational for calling acceptance of this plan “voluntary” is that it should be NPV (net present value) positive, meaning that on net, it’s a better deal, for the bondholders who market their Greek debt to market. In other words, the plan really is just a means of cutting losses because there is no realistic chance of being repaid as per the original agreement between Greece and its bondholders
Sounds like default to me. Am I missing something here?
The Huge Lessons And Questions For The Coming Week
Can this farce be maintained, even for the sake of global financial stability? How? Won’t there be legal challenges that ultimately stymie this arrangement? Won’t credit markets respond quickly to the following lesson this ‘solution’ suggests.
If the fake non-default farce can be maintained, then we now have a precedent for bondholders, especially those who bought CDSs (credit default swaps – essentially default insurance that takes effect when there’s an official default) taking involuntary losses.
That means holders of other PIIGS or other sovereign debt must anticipate more of the same. That should mean that in the near future credit markets should start pricing in the added risk from so-called voluntary non-defaults. That means Ireland, Portugal, and possibly Spain could find themselves unable to sell bonds at prices they can afford to repay.
In sum, aren’t we right back where we were before last week? We have a de facto default that risks scaring credit markets, which will spike PIIGS bond rates, prevent them from selling bonds, send them and possibly their bondholders reeling towards insolvency?
So far it appears that banks involved in this deal are simply making a logical but de facto forcedchoice to take a loss. They were forced by the imminent threat of a Greek default followed by additional, perhaps unknown massive losses from a wave of other sovereign and bank insolvencies that would follow as more PIIGS bonds go bad and inflict mounting losses on the European and global banking system.
However, such a clearly forced acceptance of less than what they were supposed to get is exactly what the ratings agencies said they’d consider default. Yet as of Friday there was no hint that any of the major ratings agencies had objected, in direct contradiction to all they had previously said.
All this leads us to question two.
Have we just exchanged a Greek debt crisis for a larger one for these other nations, possibly others?
Until we know that credit markets are somehow staying calm, be this rational or not, we stand aside and avoid trading. The market appears to have detached from reality altogether, and is thus too unpredictable.
Other Prior Week Market Movers Worth Noting
It’s unclear if any of these really mattered in the wake of the Greek relief rally, but we’ll mention them anyway.
- ECB President Trichet Signals Another EUR Rate Hike: Once again ECB President Trichet included the ‘strong vigilance’ against inflation language which markets interpret to mean rate hikes are coming. Of course the EUR was rallying along with calming fears about Greece, but with Greece at least temporarily out of focus currency markets could again focus on the growing near interest rate advantage of the EUR over the USD.
- Global Manufacturing Data Confirms Slowdown Thesis: Manufacturing data from China, the UK, EZ and India was bad. Again, though, markets only really cared about Greece, so these had little immediate effect, though they may come back to pressure markets if evidence of global slowdown continues to build.
- US ISM Manufacturing Data Positive: This may have helped stocks a bit. If US jobs data next week is positive, we could see renewed optimism about the US and a reversal in the EURUSD rally, especially if, after the expected EUR rate hike, the EUR sells off like it did after the last rate hike on a ‘sell the news’ move.
For likely market movers for the coming week as well as hints from our analysis of key technical indicators, see Part 2.
DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE REALLY KNEW WHAT WOULD HAPPEN, WE WOULDN’T BE TELLING YOU FOR FREE, NOW WOULD WE?