Hump Day and Beyond

Even though a great sense of stability appears to return to the markets after the blood-letting of Monday and Tuesday, there has been fresh developments on the ground to suggest these market moves will be sustained.  The purchasing managers surveys in Europe were generally poor with the region as a whole coming in at 47.1, down from 47.3 in the flash report and 48,5 in September.  If Europe is not in a recession, it is headed there quickly.  

The Greek situation remains unsettled by far. First is the vote of confidence slated for Friday.  It is a close call, but it does appear that the Socialist government will survive.  Although there have been some defects (at least one) and a call by one to form a national unity government, some unaligned MPS may support Papandreou.

It does appear that Parliament consent is needed to have a referendum.  If the government survives the vote of confidence, this is the next potential circuit breaker to the referendum.  Because this procedural steps have not been taken, it is not clear when the referendum will is still not clear.  Initial indications suggested early next year, but subsequent indications look like something near mid-December. 

The fact that a Papandreou called for a referendum has confused many.  Some think he is mad or shirking some responsibility or duty.  To the contrary, this is a realpolitik consideration.  His support is wavering.  He is asking a great deal of sacrifice from Greek people, who the press and many analysts are claiming is being bailed out, but it does not feel that way to the Greek people.  They are after all more in debt now then they were in the beginning of the year.  Unemployment is higher.  Taxes are higher.  The basket of goods and services they get from the government is less.  Which Greek person is getting bailed out ?  

In any event, the political calculation is simply this.  Papandreou knows he needs a mandate.  Opposition parties and his own finance minister proposed a vote in parliament that would require a super majority (180 seats of 300).  The chances of securing the super majority is slim to none and slim just left town.  Papandreou did what seek to go over their heads and appeal to the people directly through a referendum.  It looks like to this observer that the chances of winning a referendum (depending on the wording) is better than the chances of winning 180 votes in parliament.  

The entire European project, but especially monetary union, seems to be an elite project.  The gap between the elite vision and the person in the street is wide and seemingly growing.  It threatens social stability in Greece.  Papandreou's move is shrewd, but also fraught with risk.  

Neither failure nor success of the referendum will solve the European debt crisis.  The broad agreement struck  last week was unsatisfactory.  The 50% private sector haircut is insufficient to put Greece on stable fiscal footing.  In 2020, Greece debt/GDP is expected with the haircut on private investors to be where Italy is today and clearly with Italian bond yields pushing further above 6%, a record premium over Germany and rising CDS, investors are not happy with Italy's position.  

In addition, by trying to square the circle and give haircuts without a CDS event opens a can of worms that is not yet fully appreciated.   It is not just the legitimacy of that market that is called into question, but banks who bought the CDS as a hedge now are not hedged.  What will they do ?  How are they valued by investors and understood by regulators ?    Those that sold the insurance (CDS) seem to come out ahead of those that bought it as a hedge and various reports and publicly available data suggests some US banks may benefit from the separation of haircut from default.  

Meanwhile, the BOJ has not been seen in the market since Monday's record intervention.  The JPY7.7 trillion yen is roughly $100 bln and is roughly 20% of the average daily turnover of the yen.  Today the dollar is hugging the JPY78 level.  The SNB appears to have spent a small fraction of what the Japanese did (combining the Aug JPY4.5 trillion with the Oct JPY7.7 trillion) and achieved so much more.  

There are tactics the BOJ could adopt that may increase the odds of success.  For example, they need not announce there is not peg.  Strategic ambiguity might help.  Let the markets wonder.  The BOJ could also change the kind of order they give banks.  They could, if they chose, to give an order on the basis of "all or none".  They tell a bank to buy $25 mln dollars vs the yen at 77.80, but it won't accept partial fills. The bank could buy $20 mln before the market moved and it would be unable to give it to the BOJ and thus wouldn't count as intervention.  The banks can do more of the heavy lifting.  The BOJ could intervene outside of its time zone, even if it means giving the ECB, BOE, Fed, and BIS the intervention funds.  

The BOJ could intervene for a couple of days in a row.  Take that $100 bln and instead of doing it all on one day,do it over a few days, especially in thin market conditions, like after NY closes but before Tokyo is open.  Maybe early Monday, when it is still Sunday in most of the world.