By all conventional measures Greece as a sovereign nation is insolvent and all efforts to prolong an inevitable default is in essence just kicking the can down the road. Equity and commodity investors breathed a huge sigh of relief this week as the Greek parliament voted on and passed contentious austerity legislation. The new rules cut wages, raise taxes, and privatize Greek institutions there by enabling the indebted nation to receive its next tranche of a EU and IMF orchestrated bailout.
Violence erupted in the streets of Athens with trade union members orchestrating a 48 hour general strike to oppose the measures deemed necessary to avoid a sovereign default. It may just be an effort to buy time for the global financial system, still healing from the sub-prime mortgage induced crisis in 2008, to ready itself for Greece not being able to meet its debt repayment obligations. The Greeks will be returning in September looking for their next lifeline in this ongoing saga. For now, investors cheered the Greek news with the S&P/TSX gaining for four consecutive days.
The index finished the second quarter down 5.8% lower completing its worst quarter since the fourth quarter of 2008. American stocks (S&P500) had their best four-day gain since December. The end of the month of June brings with it the conclusion of the Federal Reserve’s second round of monetary stimulus known as QE2. Ben Bernanke has been clear in his recent comments that he does not envision a third round. The ongoing debate about the effectiveness of QE2 continues.
The program has been successful in fending off the threat of deflation and also helping corporate balance sheets become healthy again. QE2 has been largely ineffective at creating jobs and therefore has had little, if any positive impact on consumers’ personal balance sheets. U.S. bank shares have largely languished in the lead up to the conclusion of QE2. That may be in part due to lower trading volumes, a sluggish domestic economy, and regulatory concerns but a big part of it is the flattening effect QE2 has had on the yield curve: a diminishing spread between deposits and lending. With a steeper yield curve expected now that QE2 is over, could banking profits (and bank share prices) be due for a rebound?
With all eyes on Greece this week, Canadian CPI was somewhat overshadowed. May data did show inflation accelerating at the fastest pace since March 2003. The loonie jumped on the strong data and money markets have now priced in an 85% likelihood of a 25 basis point hike in policy rates at the October meeting of the Bank of Canada.
The Trading Week Ahead
The way this year’s Canada Day and U.S. Independence Day holidays fall on the work week calendar will likely extend the first official summer long weekend for many investors and traders. This week marks the beginning of the third quarter trading session, so there could be some portfolio adjustments from some influential market makers at the outset.
TMX Group’s plans to merge with the London Stock Exchange were scuttled last week as a shareholder vote failed to garner twothirds support for the deal. TMX will now pay a $10 million break fee to LSE and a further $29 million if the Maple Group plan goes through. TMX shareholders now have until August 8th to tender their shares to the Maple offer but the bid still faces regulatory scrutiny.
Whilst the week will start slow due to the holiday weekend, the main focus will be on Friday’s June employment data. Job creation has clearly lost its momentum since April and weekly jobless claims have been above the 400K level for 12 consecutive weeks. Today’s 428K revealed little about what to expect on July 8th. In Canada, expectations are for 10K new positions in June which continues the trend of decline since April’s 58K jobs. No change in the unemployment rate is expected.
Question of the week
With all the recent wrangling over European sovereign debt and the demonstrations opposed to austerity in Greece, could the Eurozone, and its common currency break apart?
Membership in the Euro was always intended to be forever. In fact, the European Constitution which sets the metrics for entry into the common economic and monetary union but did not build the framework for either a voluntary or involuntary exit. The strains in the euro-zone bond markets this year are driving a considerable wedge between the strongest and weakest members in the group. Concerted selling of Greek and Irish debt has forced these countries to seek emergency loans from other European Union members (Germany and France) and the International Monetary Fund.
Portugal continues to struggle with its own fiscal situation and Spain as well as Italy are in danger of travelling down the same path which may require additional EU and IMF bailouts of a much larger magnitude. Some have called for the break-up of the common currency which would enable both the strong and the more troubled nations to revert to their own national currency.
As a result, the costs for those leaving as well as those staying put would be high but not insurmountable. Weaker economies are now handcuffed by spiraling consumer prices and wage rates since the Euro’s introduction in 1999. Leaving the currency union would allow weaker members to devalue their currency and bring price and wage levels back into line with overall worker productivity levels. In addition to social unrest, these weaker Euro-zone countries would likely see a run on their banking systems and would have to impose capital control limits to stem the bleeding.
These nations would also face stiff legal challenges from businesses and depositors both at home and abroad. Raising funds to finance government operations via bond auctions would be challenging so they have to ask themselves, ‘Is staying in the union, and facing years of austerity, the lesser of two evils?’
Stronger nations would be in a much more cheerful position about leaving. Germany, the economic engine of the Euro-zone, and its tax payers are increasingly displeased with having to foot the bill for bailing out their less thrifty neighbors. If they left, their banks would be flooded with deposits and the government would be able to issue bonds at ultra low rates. Germany’s return to a new Deutschemark would be initiated by new laws saying public wages, welfare cheques, and government debt would be paid in a new currency converted at an official fixed rate.
Private pay, mortgages, and stock prices would also have to be switched to the new currency. Probably Germany’s biggest problem would be a Deutschemark that is far too strong making her exports too expensive for her trading partners.
Euro-zone policy makers have long taken for granted that the high cost of exit would in fact keep the union together. This overconfidence has kept them from implementing the measures required to hold the group together. Given the chaos of bank runs, high funding costs, and social unrest that would ensue, leaving is not a reasonable option. However, nations are now being stressed and what was once unthinkable is now being contemplated by some.
@David_RGMP