Why the world will look different this time next week.
Some of the realistic possibilities of where we'll be by this time next week
BEARISH: Risk Assets Plunge due to one or a combination of:
- Anti-bailout victory in Greece, raises risk of disorderly default and wave of sovereign and bank defaults across Europe, if not the world.
- Decisive victory for French socialists confirms austerity failed to gain support
- Failed Spain or Italy bond sales or dramatic rise in their benchmark bond yields or CDS spreads
- G20 and Troika fails to respond in a way that calms markets
BULLISH: Risk assets rally on one or a combination of
- Pro-bailout victory and/or Dramatic G20/Troika coordinated action in response to above calms markets, risk assets rally.
- Signs of falling Spain, Italy bond yields, successful bond auctions
- Massive relief rally on new that at least delays catastrophe long enough for a tradable rally.
- Note the best case scenario is one that defers a possible Lehman moment to some point far enough in the future to allow for a tradable rally in risk assets.
NEUTRAL: Ramifications from elections unclear, no major global or Fed moves leaves markets to drift.
The EU sovereign debt and banking crisis remains the most likely flash point for a crisis, so events influencing it have the most market moving potential.
1. GREEK ELECTION RESULTS, MARKET REACTION: RISKS LEHMAN MOMENT
The significance of this election is that it risks sparking a "Lehman moment, " an international run on banks that threatens global economic collapse. Specifically, the fear is that we get a coalition that reneges on the bailout agreements, it fails to reach a compromise with the EU, and that leads to a Greek sovereign default. If that happens, if that happens, then Greek banks (which hold a large proportion of Greek government bonds) and anyone with excessive exposure to them, like the Greek economy and certain European banks, collapse. Unless there is a large scale coordinated international response involving the EU, Troika, G20, etc, to support destabilized banks in the EU, then there is significant risk of contagion- a spreading wave of bank and sovereign defaults that engulfs Europe and probably the global economy. At minimum financial markets plunge and interbank lending freezes up because no one really knows which banks are still solvent and which aren't. Off-balance sheet liabilities, assorted derivatives exposure only add to the uncertainty and thus the fear.
Ironically, the very seriousness of this risk is what caused most risk assets to recover from Monday's plunge for the rest of the week and close up on the week. Traders are essentially assuming that the global leaders just won't let that happen. I mean, they'd have to be total idiots to let that happen right? Right? Hey, it's an election year in the US, and global depressions are bad for the incumbents everywhere.
If the past 2 years are any guide, even if an anti bailout regime comes in, then both Greece and the EU both make some compromises that at least allows everyone to pretend for a while longer that Greece isn't going to default. It's an illusion, to be sure, but as long as the default is pushed off for at least a few months, that could be enough for a tradable rally in risk assets.
The election is essentially a referendum on the current austerity program, and so is likely to yield a coalition seeking to renege on the current bailout deal, which is unpopular.
Why The Greek Election Could Actually NOT Be A Market Mover
First, understand that we may not have a clear idea until mid week or later about whether we get a pro or anti bailout coalition or how stable it is. Even if we have a coalition, it's likely that it will attempt some compromise deal with the EU, the terms of which may not be clear at all this week.
The Big, Immediate Risk From Greece: Run On Greek Banks, Greek Bank Collapse
While the actual meaning of the elections may not be clear next week, as long as fear of a Greek exit from the Euro remains, (or increases if there's a clear anti-bailout program victory), the ongoing run on Greek banks could intensify and collapse Greek banks and thus the Greek economy before politicians have had time to do anything.
Conclusion: Near Term Likelihood of Money Printing
In the very near term, the EU needs to prevent a collapse of Greek banking that could spark the very contagion they're trying to prevent before they've had time to work out a deal with the new Greek government. That means someone prints cash, electronically or otherwise, to keep Greek banks liquid (forget solvent for now).
Longer Term, More Money Printing: Even if individual member nations in the EU actually overcome their unwillingness to cede the sovereignty over budgets and spending needed for the fiscal integration to make the EU function, a lot of insolvent nations and banks need to be kept afloat in the interim, suggesting more money printing.
2. French Elections: Clarify French Direction
The first round of elections on June 10 suggested that President Hollande's Socialist Party would control the legislature, allowing them to pass a variety of anti-austerity policies opposed by Germany and other funding nations, seen as bearish for markets and the EUR.
3. News Affecting Sentiment Regarding Spain, Italy Prospects
The only thing preventing this from being the OBVIOUS big event of the week is that markets assume the auction will be rigged to insure success.
Greece is the likely fuse, but it's a Spanish or Italian default that would be the fatal explosion that brings down the EU. Spain has a long term bond auction on the 21st, which will provide a key measure of Spain's credibility with the bank bailout in the pipeline. If yields rise significantly or demand falls short, that could render the bailout a failure and undermine the EU's willingness to even fund it, potentially signaling Spain, and the EU's, doom. There is no more funding for a bigger Spain bailout, so contagion risk would be much higher. Given those gruesome consequences, we expect every effort will be made to insure a successful auction.
Reading John Mauldin's latest newsletter, I note he again cites one of his favorite quotes on the nature of debt crises:
Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence - especially in cases in which large short-term debts need to be rolled over continuously - is the key factor that gives rise to the this-time-is-different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang - confidence collapses, lenders disappear, and a crisis hits.
- From This Time Is Different, by Carmen Reinhart and Ken Rogoff (hat tip to John Mauldin)
A failed auction would therefore mean the EU is out of bullets. It would mean we've hit what Reinhart and Rogoff called the "bang" moment, one that signals the end of confidence, lenders, and the start of a debt crisis.
At that point, things could get very exciting very quickly. How exciting? For example, bank runs, bank and stock market holidays, capital controls, etc.
Spain , and thus the EU, is once again at teetering at the edge of the abyss, the bang moment.
See Three Reasons To Panic About Spain, Eu, And Ramifications for why last week's Spain rescue was yet another bailout attempt that will fail for the same reasons all the others have failed
4. FOMC Meeting and Statement
Many believe there is now sufficient reason for the Fed to act with new stimulus, which, depending on its size, should produce a temporary boost to risk assets. We're not so sure the Fed will move yet.
Prior stimulus actions have had only temporary benefits while piling on more monetized debt and a weakened US dollar, and so penalized anyone with savings and assets in dollars that wasn't riding a very risky US stock market or sitting on lots of gold.
Such moves this close to an election undermine the Fed's credibility as an independent body unconnected to the Obama election campaign.
If it happens at all, we'd expect to hear some justification for why this stimulus will work better.
5. EU Meetings
The following meetings are all potential sources of rumors or statements concerning Greece, Spain, Italy, or more comprehensive action. Barring a sudden crisis, the most likely venue is the June 22nd meeting of EU leaders. Expect attempts to show progress on one or more of these, preferably steps to a comprehensive fiscal integration, and how the EU will fund the GIIPS in the interim period while this integration and mutual debt sharing is enacted.
June 18-19: G20 Meeting
June 21: Eurogroup Meeting
June 22: EU Finance Ministers Meeting and EU leaders' summit.
6. Also Noteworthy: Egyptian Elections
While the results are unlikely to influence markets directly in the near term, they could potentially be enormously significant in the longer term, for its neighbors, the Middle East, and beyond. Egypt it the most populous nation in the Middle East, and thus far looks on course to become another Islamic theocracy, though an Egyptian Supreme Court Ruling last week allowed a military backed secular former Prime-Minister to run against the Muslim Brotherhood's candidate.
Before you get too enthused about the Arab Spring in Egypt, remember that democracy is likely to yield something quite different from Western liberalism.
Here are some things a majority of Egyptians polled by Pew Research supported:
- Hand amputation as a punishment for theft
- Stoning to death as punishment for adultery
- Death to anyone who converts from Islam to another religion
7. Other Calendar Events
It's a typical relatively light mid-month calendar of regularly scheduled economic events. These are unlikely to move markets unless news is quiet or unsurprising from all the above. Highlights include:
- Tuesday: Australian monetary policy meeting, German ZEW economic sentiment, Euro ZEW sentiment, US building permits and housing starts
- Thursday: China HSBC flash PMI, French, German, EU manufacturing and services PMIs, UK retail sales, 10 year bond sales, US first time jobless claims, flash manufacturing PMI, existing home sales, Philly Fed mfg index
- Friday: German IFO business climate
Consult any good economic calendar like that of forexfactory.com for details
Conclusions And Ramifications: Print or Die
We appear to be reaching the climax of the latest round of the EU crisis that began with the last round of Greek and French elections, which effectively signaled the end of the current austerity-for-piecemeal bailouts.
A comprehensive solution involving fiscal integration and mutualization of debts, leading to the US of Europe is not coming any time soon.
To prevent a wave of EU sovereign and bank defaults in the near term, we see no interim solutions other than money printing.
The big question is, if so, would Germany accept this debasement of its currency, or leave the EU (along with other fiscally responsible nations who form the block of nations capable of funding the bailouts)?
The official word is that Germany is committed to the EU. Of course, two years ago the official word was no bailouts and that Greece would be fine, thank you.
Given the enormous uncertainty, for the coming week we mostly stand aside from any active trading.
The short version: the most widely held currencies are likely to be debased through even more debt and money printing.
While markets remain nervous, and thus prone to rallies on even mildly good news, our overall bias is to safe haven assets, and a diversified basket of cash comprised of the better safe haven currencies, currencies of the most fiscally sound nations, and currency hedges such as gold, especially for those whose assets are denominated in the currencies most likely to be debased in the coming years, the EUR, JPY, USD, GBP, etc.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.