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Today is D-day for Greece and its private sector bond holders. Athens needs to reach an agreement with the banks and hedge funds to get them to accept large losses on their bond holdings, without triggering a CDS pay-out, no easy task.
Essentially Athens needs to get investors to voluntarily agree to lose money in order to try and reduce its enormous debt burden. There isn't much sympathy in the markets for Greece and its predicament. Compared to Ireland where the problems of the state seem to be centred on a handful of developers and bankers, Greece's problems seem pervasive throughout society, so it is no surprise that the negotiations have been fraught with tension.
The latest reports from the wires suggest that an announcement is expected at some point today to say that a deal has been reached. The head of the Institute of International Finance (IIF) is expected to announce the agreement at a news conference in Athens, but no time is currently scheduled. Apparently the details of the debt swap include: bonds will be swapped out for ones maturing in 30-years and carrying a coupon of 3.1%that could go as high as 4.75%. If this detail is correct it would appear that both parties were able to find some common ground during the negotiations. For example, the bond holders wanted a larger coupon closer to 4%, while Greece had resisted such a big move. But it seems like the discussions were tense, with one private bond holder saying that he had no choice but to accept a deal...
However, although the initial reports seem fairly positive we are still missing some crucial details: namely have 100% of private holders of Greek debt signed up to the new deal, and even if they have, will the debt swap trigger a default from the rating agencies. That has been the main sticking point for investors and why the final result is likely to cause a lot of volatility in the markets. If this goes ahead then this is will be the first debt re-structuring of its kind for a euro-area nation, the markets have never had to price something like this before. The source of the rally in risky assets and most notably the euro this week was on due to the lack of bad news coming from Athens, but this shouldn't be mid-interpreted as good news.
The problem is, if Greece forces bond holders to accept losses on their investments then it erodes confidence the currency bloc, even if EU authorities claim that this is a one off and haircuts won't be applied to other nations. Once there is a precedent for such a practice, who's to say they won't apply the same tactics to Irish or Portuguese bondholders?
So we are in a sea of uncertainty and no amount of talking our way out of it or into a new position will make anything clearer. That is why EURUSD retreated when it got too close to 1.30 for comfort - investors are in an environment where they are booking profits where they can, so when something looks like it is finally starting to trend (or reverse trend in the case of EURUSD) a deep pullback occurs knocking it off course. We expect this behaviour to continue and hence EURUSD has retreated back towards 1.2900 this morning.
But taking a look at the longer term charts on EURUSD then you can see 1.2600 is a key long-term support level. This held in 09 and last week, although it broke through there at the peak of the Greek debt crisis. Hence, there is a technical basis saying that we could have made a bottom in euro for now.
The next tussle for the bulls and the bears are what will the effect of ECB support (read QE by the back door) be on the single currency? Usually when a central bank expands its balance sheet then it is currency negative, but the ECB is a special case: it is expanding its balance sheet to boost the creditworthiness of Europe's troubled periphery - surely a reduction in credit risk is currency positive? This suggests range trading for me, with a slight bias higher for the single currency especially if there is a neat resolution to the Greek PSI discussions. But don't expect it to go up (or down) in a straight line.
Elsewhere, there have been some interesting developments in the stock markets today. European financials are actually moving higher as we await the Greek details, although the broader indices are falling. This suggests a couple of things to me: 1, investors are happy that European banks with Greek exposure sort out the haircut issue once and for all, essentially wiping the slate clean, and 2, that in the event of a Greek implosion even more ECB liquidity will be made available, which is positive for the banks.
Even if a CDS is triggered for Greece in the near-term, the value of CDS contracts is only thought to be EUR 3bn, so this should have a negligible impact on the markets.
European banks are due a rebound after sharp declines in 2011, so signs of stabilisation in the debt crisis could cause an outsize move higher in their stock prices. All eyes are on the euro today, but the move higher in the dollar hurt the gold price, which is testing key support at 1,642 - its 200-day sma.
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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