The panic caused by a financial market unrest in Greece may temporarily subside as the Greece government's representatives and private creditors are inching towards an agreement to cut debt. It is now widely considered a done deal unless the final outcome of the ongoing negotiation manifests itself in collapse or something new suddenly appears in Europe, especially when not expected.
The ongoing developments gave a glimmer of hope that boosted overall market sentiment. Euro made some recovery, Spanish bond yield fell and Italian 6-month borrowing cost lowered.
Why is it important to calm Greece and delay default? Despite default, Greece can continue to be a member of the European Union. It however, will, ultimately have to surrender ultimately its EU membership to keep pace with the Eurozone demand. If Greece exits, some other European nations will also contemplate a similar course.
Risk of an immediate Greece exit is profoundly grave due to financial instability in the Eurozone. It could prove to be too costly for any of the PIIGS nations already laden with huge debt that may have to follow the same path because after Greece, PIIGS nations will be left with hardly any choice.
A country that has left the membership of the EU will have to introduce its currency and printing own currency is a costly affair. It could lead to a severe pressure on economy, meaning a sharp fall in the value of its new currency.
Capital control will come into effect that could lead to many hardships for the overseas businesses. Bank runs could become a great possibility as people would rush to buy foreign currency that could throw Greece's banking and financial system into a turmoil.
Most importantly, Greece is now insolvent and therefore policy makers cannot afford its collapse. It will have a profound contagion effect on Europe that could cause an adverse impact on other global economies. So Greece will certainly get protection as long as the policymakers are able to buy time.
One thing that makes me worried or anxious about the ongoing Greece deal is the fate of Credit Default Swap (CDS). What would be the legal outcome, because technically this is a default which should be known in the next couple of months as rating agencies will be going by the book. Therefore, the biggest question whether the bond holders will get the payout for paying cost of insurance they have paid needs to be answered?
Fx & Gold weekly outlook January 30-February 03
Last week, there was a plenty of encouraging news flashed out of Europe and the US that fuelled hopes of recovery, setting a positive tone in the global financial market. The level of market confidence was so high that Fitch downgrading of Italy, Spain, Belgium, Cyprus and Slovenia could not damage markets' bullish sentiment that ended in a positive note.
The cause of delay in Greece swap deal was due to a disagreement on average 4 percent coupon rate demanded by the Greek investors, which was rejected by Eurozone finance ministers and is likely to be settled around 3.5 percent. The real cause of lowering the coupon rate is to ensure that Greece is able to manage its debt servicing and reduce its debt to GDP ratio set for 2020. According to estimates, a 50 basis-point cut in coupon rate would reduce Greece's debt by almost 2.5 percent.
Initially, it was Fed's additional stimulus offer extending its near-zero interest rate maturity period by another year that gave a boost to the market. Later on, the release of positive US economic data and market belief that Greece debt swap arrangement is almost a done deal as reports are suggesting that private creditors are finalising some of the last moment legal and technical issues encouraged traders.
But the 4th quarter 2011 GDP data shows that US growth of 2.8 percent is largely based on external factors such as Japan's earthquake and floods in Thailand, causing a build-up of inventories related to auto sales, which may not be same in this quarter unless there are some sharp US economic gains.
Although, there was some good news based on consumer-led growth, which is another important US growth indicator, as spending showed gains, the worrisome part is that the household savings had fallen, confirming reports that consumer spending was largely based on utilisation of personal savings, which could be due to Christmas and holiday season. Therefore, unless job conditions in the US improve, the pace of spending may not be the same, which means the next data will show a fall in spending.
GOLD @ $1738: Got big boost from the Fed announcement to keep interest rates low for an extended period. It also hinted that it will go for the 3rd quantitative easing. Euro's boost and Indian Rupee regaining almost 10 percent of its lost value have also helped the yellow metal. Gold now has strong support around $1718 with major support at $1702. Buyers are likely to dominate. A break of $1760 could see gold making an attempt towards $1798 or else $1685.
EURO @ 1.3218: Next resistance for Euro is at 1.3285, a break here increases risk for a test of 1.3405 with next resistance at 1.3520. However, 1.2940 is the key level to watch on the downside, a break of this level will end the Euro's bullish sentiment.
GBP @ 1.5726: Cable has experienced a strong resistance at 1.5687, a break could pave way for 1.5875. But the rally could exhaust. A downside break of 1.5540 would risk for 1.5420.
JPY @ 76.68: Yen was quick to regain its lost strength, suggesting a strong support the Japanese currency will get at 77.80, which should be cap. Risk increased for a test of 76.02, a break here could smash all barriers to test 74.60 in the coming days.
CHF @ 0.9124: Swiss Franc's next resistance point is 0.9040, a break would encourage for a test of 0.8950 or else 0.8721. However, on the flip side, a break of 0.9344 could further weaken the Swiss currency that could test 0.9546.