Greek Woes Underscore Risk Aversion Theme Today

Currency in Crisis

Three separate developments underscore the risk aversion theme today: Disappointing Alcoa earnings to kick off the US earnings season, the continued snugging of Chinese rates, including a 50 bp hike in reserve requirements (for large banks), and new worries about the outlook for Greece.

The EU has raised questions over the credibility of Greek macro-economic statistics after having revised its budget deficit estimates sharply in both April and October last year. It found several irregularities, leaving the accuracy of the government's economic reports in doubt. Meanwhile, an IMF team has arrived in Greece, ostensibly as part its regular surveillance efforts.

The issue will come to a head soon as Greece is expected to present a formal fiscal strategy to the EC and then to the European finance ministers meeting in mid-Feb. Last week, Greece announced a 20% hike in taxes on tobacco and alcohol and a higher inheritance tax.

Greek bonds are under pressure today, with the 2-year rising 11 bp and the 10-year yield up 8 bp. The spread against Germany are re-widening. The 10-year spread of 229 bp on top of Germany is about 2 bp wider from a week ago and about 20 bp wider than a month ago. At the 2-year sector Greece pays 156 bp more than Germany, 5 bp less than a week ago and 9 bp less than a month ago.

On Dec 14, we argued that the set back in the euro coupled with the significant rise in Greek yields made the short end of the Greek bond market attractive. The euro was trading with a $1.46 handle and at the time the Greek 2-year was yielding 3.05% (2.76% currently) Our rationale was that the euro's pullback was largely a year-end phenomenon and that it would recover early in the New Year. We also do not believe that Greece would exit the EMU over the next couple of years. In fact we have argued new members will join the EMU before any country exits, including Greece. Estonia is now hinted to be the 17th member of the euro zone.

There is an op-ed piece today painting a different scenario, one of Greece leaving EMU, but not for a couple of years. While possible, we still think it is not the most likely scenario.

Greece's bill auction were widely over-subscribed today. The 6-month bill was 4.18 times over-subscribed (1.38% yield) and the 12-month bill was 3.5 times over subscribed (2.2% yield). Like those who participated in the auctions, we also think the short-end of the Greek debt market is attractive.

Even if one does not have an appetite for Greek debt, the situation should be monitored. It may influence the overall risk appetite. Risk aversion is still largely seen as dollar positive. How Europeans deal with the situation may also be instructive to future issues. On one hand, ECB Stark last week seemed to argue against official help for Greece. On the other hand, Spain, who holds the rotating EU presidency said the EU will support Greece's efforts to address its fiscal problems.