Greece Needs An Iron Lady As Risk Rallies

by: Douglas Borthwick

The past week has seen the EUR/USD rise from 1.3200 to the current 1.3790 level. This has come as Merkozy have given the market a definitive date for issuance of a package to prevent Greek default. Government intervention is seeking to prevent the European sovereign debt crisis from spreading further. Over the past few nights the Chinese government has been rumored to have been buying Chinese financial stocks, providing support to Asian equities as the European crisis continues. The past three trading days have seen considerable purchases of the EUR/USD from Asian, Middle Eastern and Eastern European central banks, as they pick up the EUR/USD 'on the cheap' ahead of an expected European package.

All of this intervention is building a ceiling on the fear trade, one that was limit long as of a week or so ago. The market continues to be wearing blinders when it comes to European debt issues, and given performance numbers for September, there are very few market participants that are willing to go against the herd when it comes to position taking. Unfortunately for the market, this has created a supreme opportunity for central banks and reserve managers. Those in the 'know' have been buying European financial stocks and the EUR/USD and AUD/USD, believing as Merkel stated, that 'economists ...(looking for Greek Default)... have no clue about the economy.'

We talk to the majority of banks in the FX market, and only a few have discussed the possibility of Europe finding a solution to its current woes. Perhaps it is easier to state the obvious rather than suggest solutions. We have taken a different approach, in effect 'watching the backs' of our clients, and discussing the possible solutions that could result in a significant move higher in risk, the EUR/USD and the AUD/USD. We believe that while European issues are serious, they are less serious than those facing the US. While media reports on a daily basis the reason for US bank weakness is the European debt crisis, we note that no mention is made of the US's own crisis of confidence in its own banking system and fiscal responsibilities. It is interesting to us that if Europe's issues are so acute, then why are some large US banks down almost twice as much as some European banks YTD. If they are so miserable, then why are Irish 10-Year Bonds out-performing the US 10-Year Bonds YTD, and if they are so alarming, then why is the EUR/USD higher YTD?

Merkozy have stated all along that European issues are manageable and can be dealt with internally. These sentiments have been echoed recently by US Treasury Secretary Geithner. Europe's problem has been its inability to act. Its move to action has only been forced by the frightening look over the abyss that was experienced by Merkozy. The storm was never real as long as it was not overhead. Last week it was overhead. Certainly there is a divergence of views between France and Germany. France prefers a more socialized approach while Germany prefers each country look after itself through selling assets to reduce debt. We agree with Germany that each country can help itself to a large extent.

Greece reminds us of the United Kingdom pre-Margaret Thatcher. Back then, the UK was a country overflowing with nationalized industry and run by the unions. The Iron Lady changed all that by privatizing industry, resulting in a tremendous drop in the public sector payroll, an end to national socialism and finally a way forward for the UK. Greece has this opportunity now. Ex-ECB's Stark, back in May 2011, estimated that Greece held around 300 Bio EUR of state assets that could be sold to reduce their debt. It is rumored that he resigned from the ECB because he objected to ECB purchases of peripheral debt, in effect the Europeanization of Sovereign risk. We would argue that perhaps he resigned to further study the plan put forth by EU experts and Merkel advisers RolandBerger; a plan to sell 125 Bio EUR of Greek assets and reduce their debt/GDP from 145% to 88%, a more manageable level.

This would save Greece debt payments, but would also severely cut the number of its citizens on the government payroll. Greece wouldn't lay off these workers, rather the buyers of the companies in the privatization pile would. Privatization would bring new efficiency to the Greek economy.

The market remains convinced that a Greek default will domino into Portugal, Ireland, Spain, Italy, France and Germany. Market positions remain in this direction. However should governments actually pull off a non-Greek default, as they have consistently maintained, then asset prices in all of these countries will rise considerably. If all debt in the euro-zone is pricing in Greek default, and instead a package is announced ahead of the market, then debt prices in all of Europe will rise, helping European financial stocks rally considerably. This is the trade that few in the market want to listen to, or are prepared for. We believe it is most likely. Note that the SNB believes it will happen, as evidenced by their confidence in moving the peg higher. Note that China believes it will happen, as evidenced by their EUR/USD buying and their rumored purchase of Chinese financials. Note that the central banks of Brazil, South Korea and Russia believe it will happen, as evidenced by their recent USD selling. Global policy makers believe a solution is on its way, the market is caught short 'risk'. We take the side of the policy makers.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.