For the last few months Spain has been the biggest headache for the currency bloc, but as we move towards the final few weeks of the year Greece is once again coming back to take centre stage. It is still waiting on its next tranche of bailout funds and only just managed to scrape together enough cash to pay a large bond redemption due on Friday. An extraordinary meeting of Europe’s finance ministers to specifically discuss Greece will take place in Brussels on Tuesday at 1600GMT/ 1100ET. There is a lot of pressure on the ministers to agree to disperse Greece’s next tranche of bailout funds. The head of the IMF (and former French finance minister) Christine Lagarde has said that she hopes that the uncertainty over Greece’s next payment is resolved on Tuesday and also that the Eurozone must put Greece’s finances on a sustainable path. The IMF wants Greece’s debt-to-GDP ratio to fall to 120% of GDP by 2020, the Eurozone wants to give Greece until 2022 to achieve this. The IMF would rather there wasn’t a two year delay, but to reach the target by 2020 it would most likely mean that Eurozone governments would need to take write-downs (or haircuts) on their Greek debt holdings, which the governments’ are loath to do for obvious reasons.
Thus, there are two things to look out for in Tuesday’s meeting: 1, If Greece gets its next tranche of cash and 2, if the finance ministers’ agree on how to reduce Greece’s debt load to 120% of GDP by 2020 as the IMF has requested. An adverse outcome would be no money for Greece and continued discord between the IMF and the EU, in this case we could see the euro suffer and drift back to the 1.2650 support zone, which is also the base of the daily Ichimoku cloud, below which is the start of a technical downtrend. Risk may rally if Greece gets its next tranche of funds as this would reduce the risk of a near term default. Greece has bond redemptions of more than EU 5bn due on 14th December, so if these can be covered by the bailout funds the markets may breathe a sigh of relief. The best outcome would be money for Greece and an agreement on getting Greece’s finances and debt to GDP ratio back on a sustainable path. This outcome, we believe, is fairly unlikely.
Of course, the longer term investor will be looking for traction on Greece’s long term debt problems, which European officials still seem happy to kick down the road. But with Greek GDP contracting at a 7.5% annual pace in Q3 and the unemployment rate surging above 25% in September we are likely to see more slippage of fiscal targets. The most effective way to achieve sustainable finances for Greece is debt forgiveness, but this is looking extremely unlikely as governments in Europe seem less on Greece’s side as time passes and fiscal targets continue to be missed. Thus, the Greek debt saga is unlikely to be over even if bailout funds are released next week.
Greek problems have helped Spain and Italy fade into the background. After debt auctions last week they are both virtually fully financed for 2012. Spanish and Italian bond yields trended lower last week after the successful debt auctions, however, we don’t think this is a sign that problems are over. Both Spain and Italy have large debt issuances next year of EU 137bn and EU284bn respectively including EU 33bn of issuance from them both in January alone. Thus it is easy to see how fragile sentiment could shatter when the market realises just how much debt Spain and Italy have to sell next year especially as the ECB’s OMT programme is not yet activated.
Seemingly never-ending sovereign debt problems combined with weak growth, the Eurozone slipped into a recession in Q3 after the economy contracted by 0.1%, could weigh on the euro in the long term. EURUSD rallied as high as 1.28 on Thursday last week, however selling pressure started to build on Friday. At the weekly London close EURUSD was just holding onto the 1.27 handle. 1.2653 – the base of the Ichimoku cloud – is key support as below here is the start of a technical downtrend. This level has so far held, suggesting that there is buying interest down here; however, if we get a negative shift in the macro back drop then we could see the bears take control once more. Thus, we would look to sell EURUSD on rallies. We believe that strength will be capped above 1.28 due to a cluster of daily moving averages between 1.2750 and 1.3000 and also the top of the daily Ichimoku cloud at 1.2925 acting as stiff resistance.