Pandemonium and panic has spread through markets as Greek and related sovereign fears have intensified. The fears have turned a localized crisis in a small European country into a European and increasingly a global crisis. This is reminiscent of past crises that started in one country or sector and spread to encompass a wide swathe of the global economy and financial markets such as the Asian crisis in 1997 and the recent financial crisis emanating from US sub-prime mortgages.
The global financial crisis has morphed from a credit related catastrophe to a sovereign related crisis. The fact that many G20 countries will have to carry out substantial and unprecedented adjustments in their fiscal positions over the coming years means the risks are enormous as Greece is finding out. The IMF estimate that Japan, UK, Ireland, Spain, Greece, and the US have to adjust their primary balances from between 8.8 in the US to 13.4% in Japan. Such a dramatic adjustment never been achieved in modern history.
Equity markets went through some major gyrations on Thursday in the US, leading to a review of “unusual trading activity” by the US Securities and Exchange Commission in the wake of hundreds of billions of USDs of share value wiped off in the market decline at one point with the Dow Jones index recording its biggest ever points fall before recouping some of its losses. Safe haven assets including US Treasuries, USD and gold have jumped following the turmoil in markets whilst risk assets including high equities, high beta currencies including most emerging market currencies, have weakened. Playing safe is the way to go for now, which means long USDs, gold and Treasuries.
There is plenty of expectation that the G7 teleconference call will offer some solace to markets but this line of thought is destined for disappointment. Other than some words of comfort and support for Greece’s austerity measures approved by the Greek government yesterday, other forms of support are unlikely, including intervention to prop up the EUR. The ECB also disappointed and did not live up to market talk that the Bank could embark on buying of European debt and it is highly unlikely that the G7 will do so either. Into next week it looks like another case of sell on rallies for the EUR. Remember the parity trade, well it’s coming back into play.
Aside from the turmoil in the market there has been plenty of attention on UK elections. At the time of writing it looks as though the Conservatives will win most seats but fall short of a an overall majority. A hung parliament is not good news for GBP and the currency is likely to suffer after an already sharp fall over the last few days. GBP/USD may find itself back towards the 1.40 level over the short-term as concerns about the ability of the UK to cut its fiscal deficit grow. A warnings by Moody’s on Friday that the “UK can’t postpone fiscal adjustments any longer” highlights the risk to the UK’s credit ratings and to GBP.