Anxious wait for Greek PSI

March 7, 2012 — Mitul Kotecha

An anxious wait for the outcome of the Greek private sector involvement in a debt swap taken together with a bout of risk aversion and confirmation of weak growth in the Eurozone (Q4 GDP dropped by 0.3%) have set the scene for nervous trading in EUR/USD. Confirmation of the Greek debt swap deadline on Thursday has done little to stead nerves.

The EUR has lost plenty of ground over recent days but will likely consolidate ahead of the outcome of the PSI. Direction will then depend on whether there has been sufficient voluntary participation by bond holders to avoid forcing private sector involvement. In the event of strong participation the EUR will rally but I suggest selling into any such rally.

Another factor that is playing a role in dampening EUR demand is the fact that the European Central Bank (ECB) balance sheet continues to expand at a rapid rate, to a record EUR 3.02 trillion last week following the second ECB long term refinancing operation (LTRO). Overall, expect little respite for the EUR. Effectively the ECB is undertaking quantitative easing via the back door, which is weighing on the EUR in the process.

USD/JPY has pulled back from its highs in the wake of an increase in risk aversion. As I have been noting over recent days the move in USD/JPY had overshot its short term ‘fair value’ estimate according to my quantitative models. The drop in USD/JPY fits into line with this view. The fact that US bond yields have pulled back from recent highs has also played into the drop in USD/JPY.

While I remain bearish on the JPY over the medium term, there is scope for a further move to technical support the 80.00 level in the short term. Further out, much will depend on the ability of Japanese officials to follow through on more aggressive policy to reflate the economy.

The Bank of Japan’s inflation goal will need a determined effort in terms of more aggressive monetary policy to enable it to succeed. This will ensure that Japanese government bond yields remain suppressed at a time when I expect US bond yields to move higher. Consequently USD/JPY will likely move higher too, with my year end target remaining at 85.00.

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Greek deal reached but euro rally to fade

February 21, 2012 — Mitul Kotecha

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.

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