Heading into last weekend markets knew Merkel and Sarkozy would meet on Sunday to discuss the G20 leaders’ summit in Cannes scheduled for 3-4 November. It seemed reasonable to assume the duo – who have held regular meetings in recent months – would not come up with anything specific on a meeting three weeks away. On falsely raising expectations they have form. A deliverable plan would also need the buy-in of the other 15 Euro Zone member states and as late as last Friday, even Germany and France were at odds on how to recapitalise the banks, let alone what to do about a private sector haircut.
Germany believes the EFSF should be used for banks as a last resort once national options and the markets have been exhausted – a position that banks, who naturally don’t wish to cede power to governments – would agree with. By contrast France has argued in favour of the fund’s firepower, even if partly for fear of unsettling markets further if it talked too enthusiastically on the need to recapitalise its own banks. And yet after what we are told was just over an hour of talks, markets bought Merkel’s line that “we are determined to do whatever is necessary”.
The USD has been hit hard across the board, falling 2.5% against the CHF, 2.25% versus the EUR and the AUD and by a larger margin against the PLN and HUF. Though our central assumption remains some form of ‘controlled’ Greek default (to the extent that it can be ring-fenced) sometime in November/December, we’re sceptical the market really is buying the Merkel/Sarkozy aim of a recapitalisation blueprint by the G20 summit that would replace a 12-week old plan that has yet to see the light of day. To do so would also look past the German government spokesman’s comments today that the leader’s efforts would result in a “contribution” to the Euro zone winning back confidence and its capacity to act, but “not the miracle cure everyone keeps asking for.” Even officials are playing it down as a panacea.
Markets would also be turning a blind eye to German finance minister Schaeuble’s weekend warning of the “high risk (the) crisis broadens and escalates further” as leaders had underestimated how much they needed to reduce Greece’s debt burden by in their 21st July agreement. Though mute in recent days the IIF that oversees the PSI scheme has already said the deal for a 21% haircut cannot now be unpicked. If it has to be to gain political and voter approval, can we reasonably expect a renegotiated 40%, 50% or according to Schaeuble 60% hit to be agreed in less than month given it has taken two and a half months to get to 21%? Or is the alternative now an enforced 50% or so haircut? Are we now past the point of voluntary?
To our mind today’s sharp squeeze is as much about positioning, with IMM FX data pointing to near record EUR shorts and USD longs as at 4th October. Credit markets are short risk and it’s fair to say given the unfolding developments in recent weeks where EM equities and currencies have been hammered – the selling the ‘good’ (including gold) to pay for the ‘bad’ that investors are generally expecting the worst. Cast a net around the marketplace today and it is difficult to find folk that agree with the ensuing rally, which speaks volumes. China’s return from last week’s holidays has seen the USD/CNY fix at another new low – spurring speculation that China is doing her bit for coordinated rebalancing of policies.
Feeding into this positive mood is the news the Troika is set to rule on Greece’s EUR 8bn 6th bailout tranche, possibly within days. Compared to where we were in this phase of Euro zone policy paralysis last week, the idea of a ‘deal’ in three weeks time is surely appealing. And investors being forced to unwind positions will find this notion hard to resist because it is. Today’s rally does not say anything however, about leaders’ ability to deliver.
As always in FX, just how any particular piece of news is received depends hugely on price action at the time. With a 300 point rally in EUR/USD on the day and over 500 points or almost 4% since mid last week, news this Tuesday that Slovakia has voted No to expand the EFSF could deliver a nasty jolt. Our contacts in Bratislava suggest that if as seems likely the SaS party (one of the four party ruling coalition) votes against ratification a Yes vote is likely sometime later in the week courtesy of support from the opposition party, though the quid pro quo is early elections. That will not be an easy pill to swallow for the government and might take the rest of week – possibly longer – to agree. Such uncertainty after an initial No vote sometime late Tuesday afternoon is the market’s next directional pointer.
Without tangible evidence of a deal the current rally has its limits we think. While still a little way away, we’d expect the current rise in EUR/USD to fail ahead of 1.3850 and support now looks reasonable in the low 1.34s after the break of the downtrend. This chimes with 78.90 once again in the DXY USD index. The potentially more important question may be by the end of the week/start of next and whether a real test of 1.3850 is seen should the Troika agree Greek bailout disbursement and Slovakia ratifies the EFSF. That’ll still leave no firm Sarkozy/Merkel plan, but confidence could be bolstered.
National Australia Bank