A short summary of the key points of the EU debt crisis, where it’s obviously headed, and ramifications for investors and traders:
Per a Reuters article Wednesday, EU banks are stuck with over 100 bln euros of Greek government debt they’re unable to sell, hedge or ignore. However the ECB is in the same situation, and holds so much Greek debt that a default would mean the ECB would need a bailout.
No one wants to buy the bonds even at record low prices, and insuring the debt is too expensive to be worthwhile.
Thus the banks, at least the big ones, can do nothing but hope that when the default comes, be it full or partial, they will be bailout out along with the ECB as an unavoidable step to maintaining economic stability in the EU.
That will mean, one way or another:
Lots of money printing, a falling EUR and thus likely a rising USD
- Considerable political turmoil as politicians face angry voters seeing their tax money used to bail out private investors and preserve bank executive bonuses
Greek domestic banks have the largest exposure by far, with ~ 50 bln euros exposure per estimates. Another 50 bln is held by other EU banks, lead by German banks (19 bln euros) and French banks (15 bln euros).
Of course, the above doesn’t even consider how a Greek default would likely push other PIIGS borrowing costs so high as to threaten additional sovereign defaults, more bank losses, bailouts etc.
Many have noted that the real danger is that a Greek default becomes a systemic crisis, i.e. one in which banks don’t know which other banks are in trouble so that interbank lending shuts down and economies risk collapsing due to lack of credit and liquidity.
Remember, the mere collapse of one major bank, Lehman Brothers, was enough to kick off such a crisis – back when the world economy was stronger, less indebted, and markets were calmer.
Given the risks, we believe that there will ultimately be a major international effort to prevent such a crisis. However it’s unclear when that will happen and how far markets and the EUR will sink in the meantime.
But Will EU Voters Accept The Pain?
Complicating the task is a growing ‘bailout exhaustion’ as political opposition grows in both debtor and funding nations to the bailout and austerity programs. Citizens of the core economies are growing tired of seeing their tax money thrown down a bottomless pit, and the populations of nations receiving bailouts are increasingly opposed to austerity budgets and loss of sovereign control over their spending.
Indeed, the biggest danger to the EZ may well be that at some point sooner or later, the bailout/austerity program disintegrates as one or more nations opt out of bailout payments or their austerity obligations.
The results thus far are not encouraging. Except for Greece, not one government associated with accepting austerity measures has survived, and Greek parliamentary opposition is so strong to further austerity and asset sales that there are reports of coming new elections to serve as a referendum on Greece’s current sacrifices to stay in the EU. Greece has reportedly threatened to exit the EU unless it gets better terms.
Ireland and Portugal have turned out the leaders who imposed EU mandated austerity, and Spain’s ruling party was mauled in this past Sunday’s regional elections. Meanwhile opposition in the core funding countries has also been growing, as shown in recent German, French, and Finnish elections have shown.
Ramifications For Investors
For the time being, ramifications are fairly obvious: bias to safe haven assets like the USD, JPY, CHF, and their government bonds. Note however that the USD and JPY both have their own deep fundamental economic problems, it’s just that for now the EUR is clearly winning the race for ugliest currency. Note also that the CHF fell hard along with the EUR in the last EU crisis because Europe is Switzerland’s prime export market.
For those trading multi-week trends, like binary options traders, the bright side is that over the coming weeks the crisis will not be resolved, so betting on a downtrend in most risk assets, especially those tied to the EU, is a high probability trade.
In order to have enough time for these fundamentals to play out, we recommend weekly or monthly puts on a variety of risk assets like the EUR/USD, EUR/JPY, EU and other global stock indexes, etc.
Similarly, maintain a bullish bias for currency hedges like gold and silver, and AAA sovereign bonds like those of Sweden, Norway, and the US.
DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE REALLY KNEW WHAT WOULD HAPPEN, WE WOULDN’T BE TELLING YOU FOR FREE, NOW WOULD WE?
