Greek Deal Fails to Lift Euro

GREEK DEAL FAILS TO HELP EUR

With no major U.S. economic data on the calendar yesterday, it was a quiet North American trading session. The euro consolidated for most of the day, taking its cue from equities, which oscillated in and out of negative territory. Greece secured a second round of financing from the Eurozone, but unfortunately this highly anticipated development failed to lift the euro. The problem is that doubts linger about the country’s ability to meet its debt obligations and default. Greece still needs to persuade private bondholders to accept the PSI deal and if they fail to convince enough of them to do so, a credit event or default could be triggered. One level of uncertainty may have been removed from the market with the approval of the bailout but plenty of other loose ends remain.

This week, like past weeks, the euro has been a victim of headline risk and unfortunately this is will not change anytime soon. The only difference is that we have Eurozone PMI numbers this week. Part of the reason why the EUR/USD has been so firm is because of the resilience of the German economy. The PMI reports will provide investors with the most up to date assessment of how the Eurozone is doing – if the data surprises to the upside, the fear of recession in the region as a whole will recede. If it misses to the downside, the EUR/USD could break lower.

After more than 13 hours of deep discussions, Eurozone Finance Ministers agreed to a second bailout that will provide Greece with up to EUR130 billion in additional aid through 2014. The terms of the deal are also more generous than previously anticipated, which should help Greece achieve their goal of bringing their debt as a percentage of GDP ratio down to 120 percent by 2020. This includes a higher PSI haircut (52.5% notional haircut versus 50% previously agreed) that will bring the implied net present value loss that private investors must incur from 70 to as much as 75 percent. Greece will also have a permanent task force in place that will monitor their progress as well as an escrow account they cannot touch. Instead of passing their profits to individual European governments, the European Central Bank decided to forgo profits on their holdings and return those funds over to Greece. In other words, Greece has received a much better deal than they could have hoped. Yet the euro failed to sustain earlier gains because investors fear that it may not be the end to all of Europe's troubles. The IMF still has to decide their level of contribution and it is not clear how much voluntary participation there will be by private bond holders. A credit event (or default) could still occur if Greece imposes a retroactive collective action clause (CAC) that forces all bondholders into a debt swap. If any private bond holders decide not to participate, then a credit event could be triggered. As long as default remains a risk, the EUR/USD could have a tough time rallying. In addition, the bailout terms are strict and any missteps or deviation from program could send debt to GDP back to 160 percent by 2020. None of the bailout terms help Greece grow and recover - they only reduce debt at the expense of growth. Contagion remains a risk and we will be watching European credit spreads carefully to see if investors start pricing in this possibility. The next step is for national parliaments to approve the second bailout. Germany will be voting on the deal Monday. The IMF and EU are expected to determine their exact contributions by early March, which should be enough time to release funds for their March 20th payments.

USD: DON’T LOOK TO EXISTING HOME SALES FOR ANY FIREWORKS

The U.S. dollar ended the day unchanged or higher against all of the major currencies. With no major U.S. economic data released, the focus remained on Europe. The light economic calendar this week means that the desire for safety will be the dollar’s primary driver. The lack of a significant reaction to the Greek deal has sent some investors back into the arms of the greenback as they wonder for how much longer the market will be held hostage by Europe’s troubles. Existing home sales are on the calendar tomorrow and economists expect a small increase in the sale of previously owned homes. The housing market has long been one the country’s greatest trouble spots and unfortunately we do not expect any significant momentum in the sector until the economy enjoys a stronger recovery. Even if the housing market has bottomed, the recovery will be excruciatingly slow. Stocks on the other hand are slowly grinding higher with the Dow Jones Industrial Average perking above 13,000 intraday. The disconnect between currencies and equities suggests that their movements are motivated by different factors. Equities have performed well because of easy monetary policy while currencies have floundered because of the continued cautiousness by central banks. This leads us wonder if equity investors are overly optimistic or currency traders are overly cautious and we suspect it is the latter and not the former. There may be U.S. economic data on the calendar tomorrow but the focus will remain on Europe.