FX Briefing – Hopes of eurozone debt crisis abating

By: Milla Shaw in Forex Consultant on Jul. 21, 2011

Given the current fiscal policy uncertainties on both sides of the Atlantic, exchange rates remained relatively stable during the first half of the week. Although the week in which an agreement on raising the debt ceiling in the US should have been reached is drawing to a close, there is no sign of a solution to the conflict. However, most observers are still confident that the policymakers responsible will not let the government tumble over the brink and that a deal will be reached, if only belatedly.

In this respect, Europe has already made ogress. After the market quake in Italy, Eurogroup leaders hastened to find a solution for Greece. On Thursday, they agreed on a further rescue package for Greece. Although the statement left a lot of questions open – particularly with regard to financial sector involvement – it looks as though the new package of measures will succeed in stabilising the situation.

In addition to the funds agreed in the first rescue package, the eurozone countries will make a further €109bn available, of which €55bn have been earmarked as collateral for the contribution of private creditors. The EFSF will be used as the financing vehicle. Terms on loans to Greece are to be improved by extending maturities to 15 – 30 years and by cutting interest rates.

Secondly, private sector creditors have offered to swap their Greek bonds for new bonds. The Institute of International Finance has proposed four options: three with maturities of 30 years and interest rates of around 4.5% and 6.4% respectively. One option has a maturity of 15 years and is only partially collateralised. The new bonds will be collateralised by zerocoupon bonds from the EFSF. The swap will be the equivalent of a writedown of 21%. The Eurogroup’s statement estimates the net contribution of the private sector for the period 2011 – 2014 at €37bn, and €106bn for the period 2011 – 2019. In addition, the EFSF is to buy back bonds, which will be the equivalent to a further private sector contribution of €12.6bn.

Thirdly, the EU wants to set up a programme funded by structural funds and the EIB to promote growth in Greece and improve the competitiveness of the Greek economy. Over €15bn, the equivalent of about 7% of GreekGDP, have already been budgeted for this purpose up until 2013.

Fourthly, the scope of the EFSF is to be enhanced in order to stem contagion risks. The EFSF will be allowed to provide precautionary lines of credit, and grant loans to recapitalise financial institutions. In certain cases, and in conjunction with the ECB, it will be able to intervene in secondary markets.

The package of measures agreed will give Greece the best possible protection, in our view. It is possible that the credit rating agencies will declare Greece to be in temporary default; however, it is not likely to be seen as a “credit event” with regard to CDS. The ECB is willing to continue to refinance the Greek banking sector, presumably on the basis of guarantees. Further recapitalization of Greek banks is also being considered.

There are two key questions: firstly, can Greece live with this solution? We think it can. According to President Sarkozy, the measures will reduce Greece’s debt ratio by a total of 24 percentage points – not all that much, but quite a significant improvement. r, the EU growth programme can help to shoulder the burden of the austerity measures on the economy and the population.

The second question is: will the measures ease the situation in the other Eurozone countries? This question is harder to answer. Making the EFSF exible could help to calm down disturbances. But it is unlikely to make much difference if bond markets’ lack of confidence in public debtors persists. However, we still see the economic and budgetary situation in the other peripheral countries, and also in Italy, as much bust than that of Greece – particularly if, as is planned, the terms of EFSF loans are eased along the lines of the Greek conditions. Furtherhe adjustment programmes in Portugal and Ireland appear to be running according to schedule. The Eurogroup has also made it clear that the concept of private sector involvement is not to be used for other countries. That should reassure the rating agencies. And finally, eurozone leaders have proved that they are lling and able to take action than many critics had imagined. Thus the chances of the eurozone debt crisis subsiding have improved significantly, in our view.

On the whole, markets have reacted positively to the Eurogroup’s plans. Bond yields in the peripheral countries have dropped considerably, spreads have narrowed slightly. The spread between 10 year Spanish bonds and German Bunds has narrowed from over 350 to 280 points. In the forex markets, the euro rallied against most currencies. At the end of the week, EURUSD was about 1.44 and EURCHF around 1.18.

If the situation on the bond markets starts to calm down, this would support the euro. Interest rate hike expectations, which had diminished greatly on crisis fears, will probably correct up again. However, monetary policy stance is not expected to tighten in the short term at least: growth in the euro area has slowed down somewhat, and inflation seems to be slowing too. Therefore, provided the US budget crisis does not escalate, we are not expecting the euro to stabilise significantly in the currency markets.

Economics Department

+49 69 7183642

volkswirtschaft@bhfbank.com

Foreign Exchange Trading

devisenhandel@bhfbank.com

Matthias Klein

+49 69 7182175

Matthias Grabbe / Klaus Näfken

+49 69 7182146 / 2683

This report has been prepared by BHFBANK Aktiengesellschaft on behalf of itself and its affiliated companies solely for theinformation of its clients.

Theinformation and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHFBANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. Theinformation does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. r, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results.

This document is forinformation purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it.

BHFBANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities.

This publication must not be distributed in the United States.

This document is published by us in German and English only. Publications in other languages have not been authorised by us.

 

 

 

Similar Posts:

Share

Post comment