Stocks and also the single currency are firmer on the back of the warm words from Merkel and Sarkozy yesterday in the wake of their conference call with Greece. Whilst they are “convinced” Greece will stay in the euro area, markets are totally unconvinced that Greece will avoid default, with Greek CDS having nearly “maxed out” and 10 year yields at 25%. For his part the Greek PM committed to meet deficit-reduction targets, but there is no credibility in this promise. In May of last year, the Greek plan saw the deficit at 7.6% for this year.
If the January to August trends of this year are continued (deficit 22% higher vs. forecast), then the deficit for this year is likely to be around 11%. Herein lies the problem. The longer the EU and IMF lend to a country which is going in the opposite direction to the conditions put onto that lending, the bigger the eventual train crash will be. As we wrote yesterday in our blog, September will be seen as the month in which Greece passed the point of no return.
Guest post by FxPro
Commentary
Do not underestimate the dollar. Battered for most of this year, especially in the first few months, the dollar is enjoying a much better spell. Over the course of this week, the dollar’s gains have been more apparent against the high-beta emerging currencies of Asia and Latin America. For instance, both the Mexican peso and the Brazilian real have fallen by more than 3%. From our perspective, this improved performance by the dollar is not a surprise. Given the sovereign debt and banking drama which is crippling confidence in the euro, and with both the Swiss National Bank and the Japanese MoF prepared to risk all to prevent further currency strength, it is little wonder that the world’s foremost reserve currency is attracting a lot of inflow. Perpetuating the dollar’s apparent appeal is the perception that America’s major banks are better capitalised than their European counterparts. Large American money-market funds, which in the past have been significant buyers of European paper, are increasingly reluctant to lend to the Continent. This hesitation accounts for a good part of the funding difficulties being experienced by major banks in Europe, especially in France. In addition, European banks themselves are much less inclined to lend to other counterparties within Europe. Instead, they are choosing to lift their dollar deposits, either by leaving them with one of the major US banks or depositing them with the super-safe Federal Reserve. Since the end of last year, foreign banks have more than doubled their reserve holdings at the Fed. Clearly, European banks have been hoarding dollars at the Fed over recent months, concerned at the increasing difficulty of getting dollar funding in the wholesale market and concerned about counterparty risk. If European banks want to continue to lift their dollar reserves in the future, they may well need to buy them from US banks. In part, this is likely to contribute to potential dollar strength.
Europe’s admonishment from international leaders. Not surprisingly, the shambolic situation in Europe is attracting the ire of international leaders.US Treasury Secretary Geithner will meet with EU finance ministers as part of the regular Ecofin meeting in coming days to discuss the crisis. It is unprecedented for a US Treasury Secretary to attend this meeting, confirming the heightened alarm in Washington over developments in Europe’s sovereign debt and banking crisis. Geithner’s passport has a lot of European stamps in it these days – he was in Marseilles late last week attending the G7 finance ministers meeting, where he urged European leaders to “act more forcefully”. Last week, Geithner claimed that Europe’s crisis was “very very damaging” to the US economy last year. President Obama recently confirmed that America was “deeply engaged” with Europe in an attempt to find a solution, and implored it to get together on currency integration and coordinated fiscal policies. Separately, Chinese Premier Wen offered a thinly veiled barb in Europe’s direction, suggesting overnight that countries must “put their own houses in order”.
Asian currencies still on the back foot. Suddenly, the prognosis for Asian currencies is looking much less favourable, with global growth concerns and Europe’s sovereign debt/banking crisis both sapping confidence. The Asian Development Bank did currencies in its region no favours either, announcing that growth in the region for this year would be lower than it had previously expected. The latest decline in the Indonesian rupiah (down 4% so far this month) has been partially triggered by comments from its central bank governor, who intimated that an easing of monetary policy was possible if both inflation and growth slowed. The South Korean won also suffered, down another 1% to a 6mth low. Shares in South Korea have been hammered over recent weeks, with the Kospi down 20% since early August. Taiwan’s dollar dropped for the 8th consecutive day as foreign investors reduce their exposure to equities in the country and the TWD fell to a 6mth low yesterday.
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