G10 Currencies
EUR: “Soft restructuring“, “re-profiling“ – since the Eurogroup meeting last week the head of the Eurogroup Jean-Claude Juncker and EU Commissioner Olli Rehn have been suggesting repeatedly that there will be a restructuring of Greek debt. But they have never explained the details. So it is hardly surprising that uncertainty and misunderstandings arise. So far we have always interpreted the comments in such a way that a voluntary exchange into bonds with longer maturities is projected, i.e. a default of the outstanding Greek bonds is to be avoided. But that is only one of several possible interpretations. The rating agency Fitch and the Bundesbank President Jens Weidmann are interpreting the term “soft restructuring“ differently.
In a speech delivered on Friday Weidmann warned of the consequences of a default of Greek bonds. It would be impossible to use defaulted bonds as collateral for ECB refinancing. This approach on the part of the ECB is nothing new, what is new is the reasoning. Weidmann explicitly warned European politicians not to put pressure on the ECB: according to Weidmann nobody in Brussels should expect the European central bankers to accept defaulted bonds on their books only to avoid a financial market crisis. That would constitute a “monetisation of public debt [that] cannot be tolerated”. It is unclear whether this is Weidmann’s a personal or national view or the ECB’s approach. Should his comments reflect the point of view of the ECB this would constitute a U-turn on the part of the ECB. So far the ECB has been happy to allow a monetisation of public debt with the change of the collateral rules (3rd May 2010) and the SMP (10th May 2010) – even if it has always been too embarrassed to admit as much in public statements. Such a U-turn would be positive for the euro long term as with its current course the ECB would sooner or later get into a situation where it lost control of the inflation rate.
Fitch too interprets “soft restructuring“ as an extension of maturities of Greek bonds and made it clear on Friday (at the occasion of Greece’s downgrade from BB+ to B+) that this step would of course constitute a default – with horrible effects on the other peripheral countries, the stability of the European financial system and the reputation of the EU bailout mechanims.
In this situation there are only two choices:
• Either Juncker or Rehn quickly explain that “soft restructuring“ was never intended to mean a default of Greek bonds. This would illustrate that everything was a major misunderstanding and that only the Eurogroup’s communication policy was ill-judged. In that case the euro would experience at least a partial recovery from the losses seen since Friday afternoon.
• Or there will be no rapid statement. The majority of market observers would no doubt interpret this as Weidmann’s and Fitch’s view of “soft restructuring“ being correct. In this case there is a danger of the euro collapsing. The next important technical support (200 week moving average at 1.4002) would simply be “brushed aside“.
The other news is not euro positive either: the news of two Greeks banks, who are using measures which smack of accounting tricks to increase their refinancing volume with the ECB; the explanation of the rating agency Standard & Poor’s that it was considering a rating downgrade of Italy (increase of the existing danger of contagion); the result of the Spanish local elections, which shows that the Socialists are being punished for the savings efforts of the government in Madrid (what does that tell us about the willingness of the Spanish electorate to save?!).
USD: Should the Eurozone catastrophe of a default of Greek bonds really materialise this would certainly constitute a positive argument for the dollar – also against other currencies – as the dollar would then be best placed among the highly liquid three currencies, considering that Japan is heading full speed into recession. But that is all. A major recovery of the dollar based on fundamental reasons depends on the Fed finally ending its ultra-expansionary monetary policy. Despite the hawkish comments on the part of FOMC members Charles Plosser and Richard Fisher that does not seem imminent. The fact that hawks sound hawkish is not an argument in favour of the dollar. Only once the FOMC doves start following this view is it time to speak about a trend reversal. But the doves are still cooing. New York Fed president William Dudley made it clear in a speech that the Fed should continue to kick-start the economic recovery. The dollar is only able to benefit from the weakness of other currencies, and in particular the fact that the Eurozone debt crisis is making safe havens in the exchange rate universe seem more attractive – and the dollar continues to be one of these.
CAD: Pretended to be falling and then shot up after all – that is how the USD-CAD move on Friday could be described. While USD-CAD tested 0.9640 in the morning things began to change around lunchtime. Initially the CAD came under pressure due to weaker than expected inflation data for April, which led to doubts about an imminent Bank of Canada rate step. Then retail sales for March were disappointing. The moderate upward revision for the previous month was unable to counterbalance the red zero recorded for April (excluding cars it was even lower at -0.1% mom). Towards the end of the day weak stock and commodity market sentiment put additional pressure on the CAD. The USD on the other hand was able to appreciate on a broad basis. As there is no local Canadian economic data due for publication over the coming days general sentiment on the financial markets is likely to remain the driving force in USD-CAD. If sentiment remains downbeat a test of 0.98 in USD-CAD will be on the agenda.
Emerging Market Currencies
HUF: The die is cast. The CHF-HUF exchange rate for the repayment of foreign currency denominated loans will be fixed at 180 to reduce the debt burden of private households. This is well above the 160 originally envisaged by the government, but lower than the 190 expected by the markets. As expected banks and government reached a compromise after all. The decision put pressure on the forint on Friday. Moreover rumours started emerging during the day that due to the fixing banks were beginning to hedge against a stronger Swiss franc and that this was causing the CHF to appreciate. This seems questionable to us though. It has emerged ahead of the agreement that the difference between the paid and the actual CHF-HUF exchange rate was to be paid into a forint-denominated account for which the government was going to give the banks a state guarantee (against a fee). As a result the households essentially receive a new – forint denominated – loan which they can pay back later. The government is banking on the fact that the forint will appreciate over the coming years so that the second loan will be smaller. De facto the exchange rate risk remains with the households but has been postponed. Should banks have started to hedge their position though, this could imply that the final agreement differs from what initially has been spread. The government will publish the exact details of the fixing tomorrow. Until then the forint is likely to remain under pressure.
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Foreign Exchange