February 19th 2012: Weekly preview - Sell the Euro rally
It is a case of déjà vu again and again this week as Greece will inevitably dominate the headlines. It will basically come down to German Chancellor Merkel’s decision whether to push ahead with a deal package which totally lacks credibility or whether to put Greece out of its misery now and gamble with default and Euro exit. It looks increasingly likely that Germany is prepared to take the gamble and let Greece default. If, however, the Eurogroup does decide to prolong the agony and approve the loan deal on Monday, then any Euro rally should be seen as a huge selling opportunity.
The Eurogroup of Finance Ministers is scheduled to meet on Monday after a series of postponed meetings last week as they look to finally agree a loan package for Greece. The Greek government claims to have found the extra EUR325mn demanded by Brussels and this could in theory allow approve the EUR130bn second loan package. It is increasingly clear that this will not provide a durable solution and the Euro will be dragged down by increasingly severe tensions as French President Sarkozy faces the threat of losing his re-election bid.
Following the horrendous economic data releases last week, Greece is continuing to slide into depression. There is a very strong probability that the official data is over-estimating the problem as the ‘black’ economy will inevitably have grown even further over the past few weeks, but there is still little doubt that Greece is staring into the abyss.
There has been a notable shift in tone over the past few weeks. The pretence that Greece can return to a sustainable trajectory through the loan package and austerity measures has gradually disappeared as the glaring reality has become even more obvious. There is no possibility that debt targets will be met if austerity measures are combined with continued Euro membership. There is also no realistic possibility that the measures will survive beyond scheduled elections in April. There is no domestic mandate for the measures and the loan agreement will be broken.
There is also little doubt that much of the German government, along with Finland and Austria are pushing for Greece to default and leave the Euro area. The calculation from their point of view is that the cost of providing additional support now outweighs the benefit of providing extra funding, especially as any private-sector debt restructuring will be so onerous that it will be declared a default in any case. At best, the deal will only survive for the next 2-3 months given the economic and political stresses and the more likely outcome is that it will collapse within weeks. The Euro as a whole will also be seriously damaged by the deal as political and economic tensions will increase.
To let Greece default will be a major economic and political risk and there is certainly the possibility that the governments will look to buy more time and fudge the issue for another 2-3 weeks ahead of March 20 when Greece has to meet a EUR14bn loan demand.
The Euro-zone flash PMI data will be watched closely on Wednesday, especially after the steady improvement seen over the past three months. The Euro-zone manufacturing index has rallied to 48.8 for January from a low point of 46.4 for November and a figure back above the 50 level would provide an important boost to sentiment. There is a high risk that favourable weather conditions have artificially boosted the index, but this will be a problem for the second quarter.
The US economic data is unlikely to have a major impact with existing and new-home sales data due on Wednesday and Friday respectively and the US is unlikely to be the centre of attention during the next seven days, especially with no scheduled speeches from key Federal Reserve figures.
The PBOC decision to cut reserve requirements for Chinese commercial banks will help underpin risk appetite in the very short term. The HSBC flash PMI index will be very important for confidence during the week. The index has been below the 50 level for six of the last seven releases and any further deterioration for February would increase fears over a hard landing for the economy and trigger renewed defensive dollar demand.
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