Positions in Europe: Long Germany (EWG); We covered Spain (EWP) in the Hedgeye Virtual Portfolio today
Uncertainty reins in Greece—at least Greek government bond yields and cds spreads are indicating this as they make higher highs today.
Uncertainty has compounded along the lines of another temporary fix for Greece’s debt problems. The downturn in European equity markets, especially from the PIIGS, and the rise in bond yields over the last two days, alongside the -2% plunge in the EUR-USD yesterday (currently at $1.4143) reflect rising indecision on the fate of Greece following the inability of the Eurozone’s 17 Finance Ministers’ meeting to come to consensus on a solution; the downgrade of Greece’s credit rating to CCC by S&P; Greek protests against austerity yesterday; and calls from PM Papandreou late yesterday that he may step down, reshuffle his cabinet, or both, in the next day (or perhaps as soon as later today) as a handful of members from his slim majority ruling PASOK party have resigned over the last days (see chart below).
If confusion breeds contempt, market participants want clarity over the near term on 1.) an agreement for a bailout package for Greece, and 2.) a restructuring of the PASOK party with the minority conservative party.
Regarding point 1.), we think it’s highly probable that troika (ECB, EU, and IMF) steps in once again to fund Greece’s short term debt issues. Despite the higher highs in yields and CDS in Greece, which among “normal” conditions would clearly indicate default, the backing of Eurocrats to prevent a country from defaulting (here the ECB has the loudest voice), a currency crash, or a country exiting the Eurozone, should not be overlooked. We think this is why we’re seeing a floor in the EUR-USD around $1.40, and not freak-out levels to $1.20 or lower.
The debate now centers on a second bailout package for Greece to the tune of ~ 90 B EUR, complicit with the Greeks selling off state assets worth ~ 30-50 B EUR and more strict enforcement of austerity measures. The Germans, under the voice of Finance Minister Wolfgang Schaueble, have proposed for investors to exchange all the Greek bonds currently in their portfolios for new ones with maturities extended by seven years. This presumes lower interest rates, with the original principal paid in full at the new maturity. The extent of this haircut, however, is not known, and obviously a very substantial risk. The ECB, on the other hand, is vehemently against investors (namely private) taking on any losses, which would imply under technical definitions (from the rating agencies) default/restructuring. The ECB advocates a straight bailout for Greece.
Regarding point 2, in the larger context we don’t think a reshuffling of the ruling party is material in terms of overall market direction. The opposition conservatives’ position against austerity (~6.5 Billion EUR in tax hikes and spending cuts) doesn’t address the country’s current outside funding needs to pay off maturing debt, nor are there white horse candidates to fix years of fiscal imbalances in Greece.
In our minds, Troika holds the reins in keeping Greece half-way “solvent” as it pushes the can of debt further down the road. As we’ve stated numerous times, Greece (and some of its peripheral peers) should be allowed to default and leave the union, for under the current structure there is no way for countries like Greece to use monetary policy to maneuver around weak growth and rising debt. Further there’s no mandate from the ECB on fiscal policy for the individual members to discourage fiscal excesses. This has created relative winners and losers under one currency, a paradigm that isn’t going to change, and is most clearly evident when regions (or the globe) enter a downturn in growth.
Below is a calendar of critical meetings to address Greece’s debt issues, any of which may be a catalyst for an announcement of a new bailout package and/or a reshuffled Greek government. Among all this confusion, we remain grounded in the opinion that big brother (Troika) will once again fund Greece’s fiscal excesses. While this is no long-term solution, it should serve to cool near term market fears, support the common currency and reduce risk metrics from their highest highs to the more elevated levels we’ve seen year-to-date.
New Greek cabinet – could hear of a reshuffling as soon as later today
Greek confidence vote – could occur soon after a new cabinet is named
Sun June 19 – a pre “emergency” Finance Ministers’ meeting will be held to discuss Greece
Mon June 20 – official Eurozone Finance Ministers’ meeting in Luxembourg
Thurs June 23-Fri June 24 - summit of EU leaders to assess the 18-month-long debt crisis
Matthew Hedrick
Analyst
