Over the weekend there were further important developments regarding the Greek debt crisis. Just when you thought things had settled down a bit.....
Firstly, the German Federal Constitutional court is to meet to rule on whether Germany's involvement in the Greek bailout and Euro area's support for the periphery countries more generally is legal. The first public hearing will be held tomorrow. The verdict will not be made tomorrow and is not expected until the autumn but there should be some indication which way the Court is leaning. The final decision is binding to the German government so is critical. The plaintiffs have a strong case by claiming that the rescue measures contravene EU treaties (esp. the no bail out clause from the Lisbon treaty) and the German constitution.
Secondly, S&P have downgraded Greece's long term debt to CCC (a notch above default) from B. Significantly, the agency also said that the French rollover plan to get private creditors involved in the bailout, approved by Germany, would be a default ‘under our criteria'. This is because the creditor would get less value than through the promise of the original securities. The agreement of the credit rating agencies is a sine qua non for the French proposal and, in effect, makes it a non-starter. In any case it is riddled with holes and shortcomings and I have attached my note from last week outlining the weaknesses of the plan.
However, the Euro authorities have urged private sector participation in the second bailout. Although the 5th tranche (€12bn) of the original bailout was agreed at the weekend the ministers announced that the details of the second bailout had to be agreed. The announcement of S&P boxes the troika into a corner as it will be very difficult to have private sector participation now without triggering a ‘credit event'. Ultimately, the time bought by the votes in Greece's Parliament last week needs to be used to implement a more radical solution such as a variation of the Brady bonds used in Latin America in the late 1980's (see FT editorial today). The self-interested compromises that do nothing to address the underlying problem of solvency will not work or satisfy bond markets. The hurdle for the Eurozone to overcome is how to implement a volte face in strategy (i.e. it is a political and not an economic obstacle) while admitting to the respective electorates that the strategy pursued thus far has been wrong and wasted billions in Euros. As the FT notes this is going to be a very difficult sales job and is unlikely to be achieved in time for the second bailout. Nevertheless, the Eurozone is moving inexorably along the path to fiscal and political union as well as monetary union.
Markets have responded positively to the news from Greece last week the ‘cerise sur le gateau' was the strong ISM on Friday. The ISM suggests that the cycle is too young to die now and that it is indeed a soft patch. There will be other weak data points to come and the less predictable non farm pay rolls this week may disappoint after the strong ISM (the weekly initial claims have been suggesting a weak number). Markets have been trading sideways for several months now and I still believe the next move will be up. The chart of the FTA below shows that it is challenging its high point of the current bull market for the 3rd time having bounced strongly through the MAV last week. The advantage on this occasion is that it follows a period when there was significant capitulation in the market so there is much less bullishness and long positions in risk on trades (please see chart on attached pdf).
The containment of the risk events (threat of double dip recession and Greek default) should enable the market to break out but a short term consolidation after such a strong run is expected.
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