It is All Greek To Me

Currency in Crisis

The US dollar is broadly mixed today. Details of the funding facility for Greece spurs strong gains in the euro, lifting European currencies in general. However, the greenback is holding its own against the yen and the dollar-bloc currencies. The euro reached a high of almost $1.3700 in Asia, but has drifted off in the European session. Initial support is seen in the $1.3580-$1.3600 area. Sterling reached almost $1.55. Weekend polls continue to suggest likelihood of a hung parliament in next month’s election. Initial support is pegged near $1.54, but the tone seems more fragile than the euro. The dollar fins support against the yen just below JPY93.00. The market looks as if it wants to re-test last week’s high near JPY94.50.

The main market force today is the escalation of Europe’s support for Greece. First, it was simply verbal support for Greek efforts to rein in the deficit this year. This did not prove sufficient; so second, at the end of March Europe indicated that should it become necessary, it along with the IMF would provide some material assistance. The market was still skeptical; after all the German insistence that Greece pay market rates provided not real backstop or cap on Greek rates. This uncertainty appears to have been a factor behind Fitch’s two-step downgrade of Greece credit rating to BBB- at the end of last week. After a dramatic increase in Greek interest rates, Europe provided more details of its backstop facility for Greece. Essentially, the package consists of 30 bln euro from Europe and another 15 bln from the IMF.

To appease critics who insisted no concessionary rate, the compromise was that the rate is above what the IMF would typically charge and the rate looks to be above what most European countries pay. However, because the rates (there are both fixed and floating components, that look to be below rates the market demands from Greece, there will be vocal critics of this support facility.

Greece is to sell 1.2 bln euros of 6 month and 1–year bills today. The 6-month bill yield appears to be about 90 bp lower today at 5.35% and the 1-year bill yields looks almost 200 bp lower at 5.36%. Greece also reportedly still plans on a $5-$10 bln dollar-issue later this month. There remain several unknowns. It is not clear the conditionality tied to the financial assistance. Greece has still not formally requested aid. It is also not clear that the amount will be ultimately sufficient. Reports indicate Greece has about 11.6 bln euros coming due next month and 20 bln euros to finance in H2. The EU/IMF facility looks to be a little more than this year’s needs, but not the kind of overwhelming size, like the US provided for Mexico, for example, in 1994-1995. It is not clear what happens next year. In addition, some euro zone members, like Ireland, will have to take the issue before parliament. It is possible that one or more countries, facing their own deficit challenges, balk at contributing to Greece.

Of course, it is also possible that Greece’s financing needs to greater as the risk is that the economy is considerably weaker than the budget projected. Lastly, as we have noted throughout this crisis, underlying the fiscal issues is a larger competitive issue that Greece is barely coming to grips with. The bottom line is that we recognize that escalation of Europe’s response, and that, judging from the Commitment of Traders, speculative forces had already begun reducing short euro positions as of the week that ended last Tuesday. While these forces need to be respected, we retain a bearish outlook for the euro on medium term basis.

Rumors of an imminent Chinese yuan revaluation did not bear fruit. However, as widely tipped, China did report its first monthly trade deficit since 2004. The $7.24 bln shortfall was significantly larger than economists had expected. Imports rose 66% from year ago levels. The market had expected only about a 55% increase. Exports rose 24% from a year ago. This was a bit less than expected. China reported a deficit with Japan and Korea, but almost a $10 bln surplus with the US. Of note, Chinese vehicle imports jumped four-fold form a year ago.

Nevertheless, few will see the one month data, with seasonal distortions, as a precursor of a fundamental change in trends, or as really blunting international pressure for a stronger yuan. In fact, with import prices up 17% above year ago levels, the domestic case for a stronger yuan remains in place. Separately, China reported reserves stood at $2.447 trillion in March, up from $2.399 trillion at the end of last year. It is about $50 bln less than estimates. There appears to be a slowing of reserve accumulation and may play on ideas that China’s demand for US assets in general and Treasuries in particular may have waned. At the same, the smaller US external imbalances require less external financing. Lastly, we note that new bank loans in March slowed to CNY510.7 bln from CNY700.1 bln in Feb. Bank loans in Q1 were still 1/3 of the annual target.

The Polish tragedy over the weekend has seen a relative subdued market response. The fact that the decapitation of the country’s political and military elite did not elicit a greater market response is a testament to its institutional maturity. The euro initially rallied to almost PLN3.90 (~1%) but has since returned to unchanged levels. Polish 10-year yields are essentially unchanged and the equity market is flat. Recall that end the end of last week Poland’s central bank intervened to check the zloty’s rise for the first time.