Weekly Commentary on Financial Markets: 29-June – 1 July 2011
by Jacob H Schmidt
Risk-on , risk –off, risk-on seems to be the pattern, due to the many political, macro and some micro events.
While Greece’s parliament voted in favour of both the austerity package in general (Wednesday) and its implementation (Thursday), many Greeks went to the streets. As soon as the vote went though the markets lost interest in the story and moved on. French and German banks were reported to support an extension of bond maturities by up to 30 years with a coupon of 5.5%. The rumour has it that these bonds will be held such that they would not have to be marked-to-market. Assuming that the principal is guaranteed (some called this plan a European Brady) the bonds real price is between 30-50 (assuming current yields of 11-20%). However the real issue is: can Greece afford it. While a 5.5% COUPON sounds generous (much cheaper than the 20% yields in the markets) Greece cannot afford 5.5% on EURO 350 b. Hence what Greece really needs (and the markets keep telling the politicians) is a significant haircut on the stock of debt PLUS a reduction in interest rates. The experience in LATAM shows us that a Brady plan is the last step of any restructuring, and it is painful: Mexico got 30%, Poland 50%, Bulgaria 70%. And the coupons were low too. Hence we believe that a real Brady is to come at some point, once the default and / or big discount in a restructuring has been accepted. In any event, the numbers tell more than a 1000 words. After the vote Greek 5 year CDS have rallied from 2170 basispoints to 2020 today, but still higher than last week’s 1950 bp. Greece’s aid for the next 3 years (2014) will be in the EURO 195 b range, without guarantee that the lenders will get their money back. Some bankers and politicians have even come up with a “Marshall Plan” idea for Greece. A very good idea, but the timing might be premature.
Strong US data on Friday helped markets to continue a summer rally (as forecast by us two weeks ago), and with the earnings season starting next week, the equity markets might continue to rally. Interestingly the equity markets seem to shrug off the US debt ceiling issue, which will have to be dealt with in the next 2-3 weeks. The rating agencies (again the power brokers, to our surprise) have warned that any delay in payments et al could lead to a selective default. While a delay of this matter would be a serious error of judgment of the politicians and the markets’ reaction might be very negative (for a short period of time) the rating agencies find themselves in a tricky situation: if they downgrade the USA, they might lose their oligopoly, if they do not react, the markets will accuse them of being hypocritical. We believe that ratings on sovereigns which are highly political have nothing to do with a proper credit analysis, but rather reflect a view on politics.
More news of civil unrest in China reaching us, potentially a bigger risk than the slow down – soft landing of the economy. In political history states fail not because of economic or financial problems but because it becomes impossible to administer them (see Roman Empire, USSR et al). China might be on a similar path.
Other good news included Christine Lagarde’s appointment as the IMF’s first female MD as well as the news regarding DSK’s lifting of the bail after revelations about the hotel maid’s back ground. DSK might be back in the election game.
Summer rally likely continue here to push markets to new highs. Increased chance of shocks due to more systematic and political risks.
Conclusion: As I wrote last week: after quick fix of Greece situation repeat of Lehman 2008 averted, but by no means solved. US debt ceiling, China unrests, political woes in MENA et al pose plenty risks for investors.