Markets continue to witness a broad based sell-off, as the lack of policy response from Europe holds any potential risk rally captive. Risk reduction remains entrenched, as yesterday's announcement that Greece would once again face larger deficit than originally anticipated, played into the markets fears. Although, this shouldn't be earth shattering news to anyone paying attention, since the IMF estimates forecasted such an outcome. However, it is disturbing due to the fact this was predicted and Greece walked right into the result. Government reports showed that GDP is expected to fall 5.5% in 2011, and 2.5% (upper limit) in 2012. A deficit short fall should come in at 8.5% of GDP, over the previous 7.6% parities agreed on. The Greek government was quick to issue statements regarding further spending cuts to close the gap. It's deja vu all over again and that is a worrying fact, to the markets, as well as European policy makers. Various media sources have reported that the Troika meetings have not concluded, but there is an expectation that they will end this week. EURUSD still having a hard time finding buyer as the pair dropped to 1.3164 from 1.3389 and AUDUSD fell to 0.9456. Asian regional indices were all in the red, following US equities, with Nikkei down -1.05% and Hang Seng -0.84%. The growing tensions between the US & China after the Senates successful vote to allow USA businesses seek duties on Chinese imports also added to the negative sentiment.
While we are unconvinced regarding Greece's budget and progress on reform, we suspect that Troika will release the 6th tranche regardless. News that a forced bankruptcy has been avoided should be EUR positive in the short run. In today's FT Deutschland there is a report that Greece's PM Papanderou is pondering an early resignation, but we suspect there is little accuracy in this story. Official spokesperson was quick to denounce this report at nonsense. In addition, yesterdays ECONFIN meeting provided no news specifically around the enhancing the EFSF. As for today meeting we are not expected much but wouldn't be surprised if the group passed the buck once again by stating that Greece would be required to ratify its 2012 budget before the next Tranche would be released. And more discouraging is rumor that the next finance minister meeting scheduled for Oct. 13th has been postponed.
In Australia, the RBA held the overnight cash rate at 4.75% which was broadly in line with market expectations. The accompany statement highlighted the uncertainty on the global growth forecast and the spillover effect on the domestic economic conditions (specifically labor markets a core source of price pressures). The expectations of moderating growth means the RBA is more willing to accept short term inflations pressures. On the data front, August trade balance $3.1bn vs. $2.0bn exp, $1.8bn prior while building approvals 11.4% mom vs. 1.0% prior.
While we are on watch for any news on regarding the leveraged EFSF and next tranche of cash to Greece, it is going to be Thursdays ECB meeting which will be the markets main focus. This will be Trichet's last meeting as the ECB chairman which adds its own element of uncertainly. Despite last week's surprisingly strong inflation data, we expect the focus will remain on the mid and long forecast, which should allow pressure to subside. We do believe the ECB will lower rates twice, in Dec and March, but will limit loosening this time around to non standard measures and not shifting the policy rates. We believe Trichet will be mindful of setting a course before Draghi has a time to take the reins. That being said, there is a significant group expecting a 25bp to larger 50bp cut. The EURUSD has been highly sensitive to interest rate differentials. While the rate market has already priced in roughly 25bp worth of cuts, FX has yet to shift. A straight 25bp or 50bp policy rate cut will push the pair significantly lower (although we are seeing some unwinding of long positions).