Dollar Broadly Stronger as Greek Deal Lacks Closure
The US dollar is advancing against the majors and most EMs as the “sell the fact” theme prevailed following the approval of the Greek bailout. The euro initially rallied to 1.329 in the Asian session but has gradually declined after two failed attempts to break 1.330. Near-term support seen at 1.315 with 1.330 remaining a key level of resistance. Most of the G10 pairs are weaker against the US dollar, with the Australian dollar leading losses down nearly 1%. Sterling is currently down 0.3% to 1.580 after stalling ahead of 1.587. The yen is trading flat against the dollar after edging up to 79.85 highs, with 80.00 a potential source of price congestion due to pre-fiscal year-end hedging. Global equity markets are mixed, with the MSCI Asia Pacific trading flat. The EuroStoxx 600 is down 0.6% led by the 1.2% loss in banks.
A Greek deal has emerged from the marathon meeting of European finance ministers, but it is far from clear that it ends even this chapter of the saga. Attention will turn to the participation in the PSI. The agreement struck appears to be more onerous than initially anticipated. Part of the deal also includes reduction in the interest rate on the previous international assistance and there is no reason why those lower rates should not apply to Ireland (which is seeking relief on promissory notes used to recapitalize its banks) and Portugal. Perhaps most importantly, the package does not give confidence that this solves Greece’s problems, even if PSI is acceptable and Greece actually does implement the agreements.
The Greek deal stands on two legs–austerity and debt restructuring. The clear and present risk is that these measures prolong the economic downturn and that another aid program is needed in 1-2 years. In addition, the economic demands on Greece have undermined its political stability. In effect, Germany’s controversial proposal for a EU Commissioner and making debt servicing the top priority born fruit in the form of a European Commission task force being embedded in Greece in an "enhanced and permanent presence on the ground" to improve the workings of Greece’s bureaucracy. An escrow-like account is also being established that prioritizes Greece’s solvency (ability to service its debt) over the other demands on the government’s budget. Of the €130 bln aid package, the vast majority (roughly 85%) is being used to bail out lenders not bail out Greece. Specifically, €30 bln is for the cash component of the PSI, €35 bln euro is to fund the government’s purchase of bonds held as collateral by the ECB. Another €40 bln is to recapitalize Greek banks, on top of the €10 bln earmarked from Greek 1.0 that has not been used. EU officials have admitted they under-estimated the challenge presented by the weak administrative capacity and weak political unity in Greece. Not only do they appear to be risking repeating this mistake, but also of bleeding the patient they hope to save by pursuing the pound of flesh in the name of the creditors.
The Reserve Bank of Australia’s (RBA) monetary policy minutes for February point towards another likely pause in March. Overall, the minutes were largely in line with the initial policy statement by reiterating that the RBA is ready to ease conditions further if demand conditions deterioration from here, suggesting the threshold for a rate cut is higher than many anticipated. In fact, the biggest surprise of the minutes is was how far it appears the RBA was from easing in February. The minutes also reinforced many of the themes in the recent RBA communications. First, it highlighted global growth is likely to be below trend with Europe in recession. However, it also indicated that the tail risks of an extremely bad outcome have diminished considerably. Second, it highlighted its outlook for inflation once the disinflationary impact of the strong Australian dollar passes. Third and finally, private sector lending rate is currently around the long-run average, which is appropriate given growth is forecast to be around trend and inflation in the middle of the target band. Yet given the strength of the recent employment report and the diminished tail risks of a crisis in Europe we expect the RBA will remain on the sidelines in March.
The rally in EM FX has lost some steam in February even though equities continue their strong performance. In January, the top 10 performers saw gains ranging between 4.5% and 8.2% against the dollar, while the S&P 500 rose 4.4% and the MSCI EM was up 11.2% (which includes currency appreciation). In contrast, the month-to-date performance of the top 10 EM currencies ranges from 1.6% to 3.8%, while the S&P 500 is up 3.7% and the MSCI EM is up 4.6%. We interpret this as a first signs that the stellar performance of the high-beta EM currencies may be behind us. The short covering of high beta and current account deficit currencies (ZAR, INR, TRY, HUF, BRL, KRW), which was the popular trade late last year, seems to have been largely cleared out. Although we think EM can extend its gains against the dollar should risk appetite hold up, we adopt a slightly more cautious approach for now. As such, we prefer to rotate out of the high betas currencies in favor of the lower beta currencies and ones where central banks are not yet resisting appreciation, such as PLN, SGD and MXN.