ECONOMETER

The EUR rallied on the news of a breakthrough in talks to reach a deal to provide Greece with a second bailout of up to EUR 130 billion until 2014 and PSI (private sector involvement) in a debt swap with a nominal haircut of 53.5%. The question is whether the EUR has room to rally further. I suspect that a deal has been increasingly priced in and the room for further appreciation is set to be limited in the short term.

A stronger EUR shows some confidence in the ability of officials to move forward but will prove counter productive given the negative impact on the Eurozone economy at a time when growth is already sliding into recession. Moreover, the relative rise in US bond yields compared to bund yields will create headwinds to any further EUR appreciation. Overall, we are cautious of buying into the EUR rally at current levels.

Effectively the deal buys time for Greece to implement its stated reforms allowing the debt / GDP ratio to drop to 120.5% by 2020. The private sector debt swap procedure will be launched tomorrow. However, the deal was reached shortly after a report that suggested that Greece may need a further bailout on top of the EUR 130 billion announced.

The report which highlighted the risks of an especially deep recession in Greece and consequent risks to reducing the county’s debt / GDP ratio explains the reluctance of countries including Germany, Netherlands and Finland to agree on the proposals.

The bottom line is that the positive impact on markets may fade soon. There was already a great deal of expectation built into the rally in risk currencies over recent weeks and it is doubtful whether the final announcement of a Greek deal will be sufficient for the rally to continue.