John Kicklighter of DailyFX.com
provides analysis and commentary in response to five questions about news themes
that are primary drivers of the forex markets these days.
Is a deal on Greece’s second bailout already priced in the markets?
Will the focus move to Portugal?
It is impossible to fully price in the outcome of the Greek situation. It is
simply too complex.
When we have big reactions to event risk, the change in price is the
adjustment to the new “fair value.” When we didn’t see a significant development
coming, we get the biggest market reaction. Should we know what is coming-but
not the exact outcome or timing-the impact can be significant, though it is
usually not as dramatic.
The missing components here are what exactly will be done for/to Greece and
when will it happen. The leading consensus now is for the private debt swap to
happen with a 70-plus haircut and low yield that will advance the second public
bailout, which requires more austerity.
Having everything line up for a Greek private and public rescue wouldn’t be
as market moving as failure considering that eventual optimistic outcome is
expected (and is significantly priced in with the current “bid-for-time”
effort). Still, there are so many moving components here that failing to meet a
reasonable solution by March (when the next bond payment is due) is a serious
risk.
Making special accommodations to just pay that tranche to carry this forward
would probably permanently lower confidence in the euro’s position. Caving to
default calls would have the greatest impact in this scenario with a euro
tumble-though this possibility would not be too shocking to a significant
portion of the market (and therefore wouldn’t carry a multi-month bear trend).
As for Portugal, the worse the situation for Greece, the more attention the
fellow bailout member will attract. Greece will likely remain the critical
denominator in this equation until it is receives absolute support or succumbs
to default.
Do you expect Mario Draghi to introduce new policy measures to help
the Eurozone economies, such as a rate cut or other policy
measures?
If the time frame for this view is six to 12 months, then absolutely. Should
our outlook period be limited to just this upcoming policy meeting, the
probabilities are much lower.
Heading into the February central bank decision, the market (overnight rate
swaps) is pricing in approximately a 55% chance of a 25 basis point (bp) rate
cut. That said, the 12-month forecast isn’t pricing in a full, quarter-percent
cut and the economist consensus is for a stay at 1.00%. That degree of
variability in the outcome could be good for a moderate reaction to the outcome.
An actual change to the benchmark would carry the most influence, but the
commentary that sets the tone for future policy decisions is just as important.
Given the improvement in regional sovereign bond yields and liquidity measures
over the past month, Draghi and company will likely keep the wait-and-see
character in the statement and answers.
Announcing an abnormal policy change would be quite remarkable for the ECB
(in other words, it would probably require severe strain). The central bank has
already implemented the first long-term refinancing operation (LTRO) and will do
the second at the end of this month. They are also buying up government debt
without targets or an objective (all the while saying it is not a QE effort like
the Fed or Bank of England).
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