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In the ancient epic poem known as the Odyssey, the Greek king Odysseus was forced to navigate a narrow strait between the six-headed sea monster named Scylla, and a ship-eating whirlpool called Charybdis. As it was impossible to avoid both, he chose to confront Scylla, losing a number of his best sailors in the battle that followed – but averting utter annihilation.
In the next few weeks, Greece will face a similar choice; between defaulting on its obligations to international creditors in the Eurogroup and at the International Monetary Fund – or defaulting on salaries and abandoning promises made to citizens during the recent election. The country’s borrowing costs have exploded upward in recent days, with three-year yields touching 27% as market participants become increasingly convinced that a default is imminent.
After years of crisis, many observers might see this as yet another “boy who cried wolf” situation, but there are signs that the threat is real this time. Agreed-upon reforms have not been delivered, political positions have hardened substantially, and Greece has asked the IMF about delaying a payment due on May 12th – something that only a few impoverished African countries have done previously.
Euro area policymakers are reportedly drawing up plans to manage a Greek default within the common currency zone, and there is some likelihood that this could be accomplished with a minimum of disruption – but this would still be the largest default in history, and would unquestionably destabilize global markets.
With Greece simmering in the background, risk premia are rising, pushing increasingly cautious investors and speculators out of the momentum trades that many have been riding for the last six months.
Somewhat counter-intuitively, our theory is that the situation is helping to boost the euro higher, by making carry traders less confident about investment prospects in other areas of the world. This echoes the dynamic that made the currency surprisingly robust during the early years of the crisis.
In contrast, the US dollar is ending the week on a softer note, after jobless claims, housing starts and factory activity numbers all disappointed against expectations. Market participants are gradually pushing rate hike expectations toward the end of the year, and
Here in Canada, a rising crude price and a jump in retail sales are helping the currency to surge on a trade-weighted basis.The loonie is trading almost eight cents above levels hit in early March, after Statistics Canada reported a 1.7% rise in February retail sales, combined with a 1.2% annualised increase in prices.
Canadians continue to spend like there’s no tomorrow, making investors happy, but adding to our concern that overleveraged consumers will make the rebalancing process longer and more difficult than policymakers currently anticipate – particularly in the event that external influences derail an extremely vulnerable housing market. Businesses that are short dollars should strongly consider taking advantage of today’s levels to take some risk off the table – the opportunity may be quite short-lived.