The Global Markets Weekly 10/28/11

Posted October 28, 2011 by CLeahey

[private][private]Markets to EU: Details, Please!

The focus last week for markets was on the Eurozone leaders’ Summit, which saw EU leaders announced a three-pronged plan to tackle the region’s sovereign debt crisis.  First, the plan included an attempt to reduce Greece’s outstanding debt to 120% of GDP by the end of the decade, with the move likely to see bondholders accept a 50% (voluntary) haircut on their debt payments.  Second, the EFSF would be juiced up, with policymakers expecting it to exceed €1,000B.  (A SPV financed partly via the IMF and Asia, to support the EFSF in also in the works).  The final part of the plan required the region’s banks to raise their tier one capital ratio to 9%, or roughly €106B.

Markets initially greeted the program with enthusiasm and then had second thoughts as details remain very sketchy.  In particular, investors wonder where the “wall of money” to stop contagion will actually come from.  Yes, bondholders will voluntarily take a 50% on their Greek debt.  But how would the remaining 50% be guaranteed?  And would the CDS contracts be invoked since this is a default in all but name?  And, a target of 120% debt to GDP ratio in 2020 does not seem like solving the Greek problem.  Yes, banks would be raise to raise €106B in capital (on the very low end of the €100B to €300B investors think is needed) but how would this be done without some taxpayer help?  Selling assets would bring balance sheets and worsen EU activity.  Raising capital via equity sales might find few buyers.  Yes, the EFSF would be enlarged but would investors really believe in this enlargement have meaning unless German (and French taxpayers) kick in more money. And a Chinese financed SPV may end up being a pipe dream.

Merkel knows that the Germans will not pledge more funds until they see some reforms by the countries needing funds.  This explains her insistence on quickly installing German style “debt brakes” in the pan-European government finances.  Achieving fiscal union is probably the only way the euro can exist in anything close to its present form.  But this takes time and more cash will be needed to keep Greek and the euro afloat.  Germany has once again put the cart before the horse.  Because without more “real cash,” this summit only gave us another set of increasingly larger band-aids.

• U.S.: The big numbers this week will be mildly constructive.  Employment numbers should show weakly positive jobs growth, with a potential decline in the un. rate.  ISM surveys should inch higher but remain well below early-year highs.  The FOMC will make no substantial policy changes given the more positive news of late and having made big changes the previous two meetings.  Still, their optimistic numerical outlook will be downgraded and they may announce changes to their communication policy.
• Eurozone:  While investors will focus on the upcoming G20 Summit, attention will also shift to the ECB Council meeting be chaired by new president Draghi.  Expectations of an immediate policy rate cut have diminished.  The PMIs should confirm the weakness seen in the flash estimates will keep talk of an ECB rate cut alive.
• United Kingdom:  Q3 GDP is the main even with a flat trend expected to continue.  Otherwise, the main focus will be the PMI numbers and an update on house prices from Nationwide, a figure that may further highlight the flat to slightly lower trend.
• Japan:  An upcoming speech from Shirakawa provides a highlight the Outlook report findings.  BOJ minutes will also appear.  Strong vehicle sales and reconstruction-boosted housing starts are also on the calendar. 
• Australia: Market expectations have shifted towards a rate cut by the RBA following the moderation in Q3 inflation data released in the previous week.
• Emerging Markets/Regions:  Only one major central bank, the Czech Republic meets this week.  They are unlikely to make waves, leaving rates on hold at 0.75%.  Downside risks to the inflation outlook are likely of slightly greater concern given the external environment, even though the koruna has been volatile.

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