Catastrophe averted, market’s reaction exaggerated

There are signs of a some kind of a compromise on Greece eventually. Here is what leaders decided:

Private creditors will take voluntary haircuts of 50% on the Greek debt – this was seen as a minimum to restore Greek fiscal path to sustainability. However that may only happen if economic conditions improve. Total Greek debt will be reduced by less than 30% and that will result in a debt/GDP ratio of 120% but only at the end of 2020! So it’s still a hope and see scenario.

Banks will need to raise 106 bln EUR of fresh capital to absorb losses on the Greek debt. The bad news is banks will need to test the markets before getting a helping hand. And what if speculations about a necessary haircut for other countries (implying even larger capital needs) arise?

EFSF will be bolstered through the SPV and guarantees of new debt issuances. Assuming there will be no more disagreements and details will be agreed on smoothly and presented clearly Europe will finally have a tool to fight contagion. But ultimately Europe needs to eliminate the cause – stopping a contagion from spreading (while important) is not enough.

Actually, there’s nothing new in those solutions. They will avert the catastrophe for now but it’s not a miracle. Meanwhile markets act as if that was a miracle or at least a bazooka option. That would include a larger reduction of the total Greek debt, providing a clear mechanism for banks to tap EFSF (so they are not exposed to the market if they thought raising capital there might be difficult), providing a clear mechanism of bolstering the EFSF and last but not least pledging some structural reforms across the euro zone (including larger countries like France or Belgium). That would be something to cheer about – what was decided (and implementation might be another story) is an absolute minimum that was necessary.

Keeping that in mind and looking at the markets that rallied strongly in October we struggle to see any further upward potential for both EURUSD and equities and actually we think market overreacted. EURUSD is likely to suffer on the interest rate cuts expectations and investors on equities probably forgot that we are in the slowdown phase.

Przemysław Kwiecień PhD, Chief Economist

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