Markets expect a Greek default; now a 98% certainty

By Sam Coxhead*:

The major theme of European debt inspired risk aversion, continued to play out through the course of last week’s trade.

Risk aversion reached a peak in the offshore session on Friday, as the odds on a Greek Government debt default again increased.

Markets are pricing in around a 98% chance of default from Greece, as they struggle to implement the spending cuts necessary to ensure further bailout funds from the ECB, EU and IMF.

The main beneficiary of this risk aversion has been the US dollar, as safe haven demand pushes it higher on almost all cross rates. The unprecedented Swiss National Bank (SNB) implementation of a “floor” on the EUR/CHF at 1.2000 to curb Swiss Franc strength, will have added to the US dollar demand.

Interestingly the economic numbers from China remain relatively robust, with import demand a sign that activity remains strong. The strength of the Chinese economy should offer some support for the Australian and New Zealand dollar, both of which have been under pressure, as the risk aversion has increased in recent weeks.

Major Announcements last week:

· UK Services PMI 51.1 vs 54.3 expected
· RBA leaves cash rate unchanged at 4.75% and maintains wait and see approach for future direction
· US Non-Manufacturing ISM 53.3 vs 51.2 expected
· Australian GDP 1.2% vs 1.0% expected and previous revised up from -1.2 to -.9%
· BOJ leaves monetary policy unchanged as expected
· German Constitutional Court allows Eurozone bail funds to be offered
· BOC leaves the cash rate unchanged and moves to neutral bias- downside economic risks realised
· Australian Unemployment rate 5.3% vs 5.1% expected
· BOE leaves monetary policy unchanged - further QE expected in the coming months
· ECB leaves the cash rate unchanged but moves to neutral bias (at least) from tightening
· Chinese Inflation 6.2% vs 6.3% expected
· US president Obama announces 447 billion USD jobs plan and receives luke warm response from the market
· Chinese Trade Balance 17.8B vs 24.7B expected, driven by strong import demand, healthy number
· Canadian Unemployment rate 7.3% , as expected

NZD/USD 
The NZD has softened further on the open this week, after the meltdown on Friday. Initial support will likely come in at .8100 and then further support at .8000 below. With the exception of the Rugby World Cup, the only NZ focus of the week is the RBNZ cash rate announcement on Thursday. No change is expected but the accompanying statement will be closely watched. In the US, retail sales numbers on Wednesday, inflation numbers Thursday and manufacturing and consumer sentiment numbers Friday will be watched. Overall the driving force may well come from Europe. If the Greek default proposition gains further traction, expect the USD to remain in demand and therefore outperform the NZD.

NZD/AUD (AUD/NZD)
The AUD outperformed the NZD last week, as the RBA stanchly maintained their “wait and see” approach to changes in the cash rate. The pair remains in its familiar .7800 - .8000 (AUDNZD 1.2500 -1.2820) range, but barring a surprise from the RBNZ on Thursday, expect the AUD to maintain the upper hand in the short term. A consolidated break lower through .7800 (AUDNZD 1.2820) would see further pressure on the NZD. There is little in the way of top tier economic data in Australia this week, so the RBNZ will be the sole focus.

NZD/GBP (GBP/NZD)
The NZD was relatively stable against the GBP for much of last week. The NZD was boosted by the mostly positive AUD news, but its appreciation was hard fought amongst the waves of risk aversion. Ironically the “dovish” tones from the BOE have been countered by the markets shunning of growth assets like the NZD. Friday saw the NZD under renewed pressure and this has continued this week. The primary driver will again be the general market risk appetite with the GBP likely to outperform if European debt concerns escalate once again. The RBNZ cash rate announcement on Thursday will be watched, but expected to be no change. UK inflation and retail sales numbers on Tuesday and Thursday respectively will also garner attention, but will most likely have little material impact given the other big issues at play.

 
NZD/CAD
This pair had a relatively volatile last week, as the general risk aversion saw the NZD under initial pressure, before the Bank of Canada monetary policy announcement caused the CAD to come under some pressure. The Bank of Canada are now likely to hold their cash rate at 1%,  as they described the downside risks to the global economy as having materialized. This week it is the turn of the RBNZ on Thursday and this will be the primary focus for this pair. Should the European debt issues continue to inspire risk aversion, the NZD will continue to remain under pressure.

NZD/RAND
The NZD traded a relatively small range against the RAND throughout the course of the last week. The disappointing GDP numbers in South Africa mean that there is renewed pressure on the South African Reserve Bank (SARB) to keep the cash rate low for an extended period of time. Expect gains from the NZD to be harder fought from the current high levels. There is little in way of economic data for either countries this week, so expect the current wider range of 5.85 - 6.15 to limit the movement. The next SARB cash rate announcement on 22 September will now be very closely watched, and should give a good guide to interest rate direction in South Africa in the short term.

NZD/EURO (EURO/NZD)
The NZD unsurprisingly outperformed the EUR throughout the course of the last week. The Euro-zone debt fears have intensified as the proposition of the Greek default increasingly has the solvency of the banking sector under the spotlight. The resignation of ECB board member Stark further fuelled fears about the financial leadership in Europe at this important time. Apart from the constant focus on Europe, expect the market to carefully watch the statement from the RBNZ as it is expected to leave the cash rate unchanged on Thursday.

 
NZD/YEN (NZD/YEN)
This pair was volatile over the last week with the NZD suffering late in the week from rising market risk aversion on the back of the European debt crisis escalation. This week has started with the sentiment continuing. Expect the NZD to find some level of support as we approach levels where interest rate differentials really start to come into play. The RBNZ cash rate decision and accompanying statement will be closely watched on Thursday, but for the most part general market sentiment will provide the lead. Initial support will come in at 62.50 with further support at 62.00.

AUD/USD
The AUD outperformed the US dollar for most of last week amongst some stronger than expected growth numbers for the 2nd quarter and the wait and see approach on monetary policy from the RBA. The higher than expected unemployment rate in Australia started the weakness and the escalation of debt fears in Europe quickly saw the US dollar on hot demand in Friday’s offshore session. There is little in the way of Australian economic data this week, so expect the lead to come from the US and the situation in Europe. In the US, we have retail sales numbers on Wednesday, inflation data on Thursday, and manufacturing and consumer sentiment numbers Friday.  The solid Chinese trade numbers late last week should support the AUD if the risk aversion abates at any stage this week.

AUD/GBP (GBP/AUD)                            
After initial softness to start the week the AUD gained against the Pound Sterling as the RBA’s “wait and see” approach to monetary policy and stronger than expected growth numbers saw the AUD in demand. As the risk aversion increased towards the end of the week, and the Australian unemployment rate notched up to 5.3%, the GBP found support. This has continued into the start of this week and may continue if the debt situation in Europe continues to escalate. There is no top tier economic data in Australia this week, so focus will be in the UK. This starts with inflation numbers on Tuesday and is followed by the retail sales numbers on Thursday.

 
AUD/EURO (EURO/AUD)
The AUD outperformed the EURO last week. Initially the demand was driven by the “wait and see” approach from the RBA to monetary policy, and the better than expected growth numbers. The ECB also have lost their tightening bias towards the cash rate, as the European economic outlook deteriorates. As the debt concerns rose towards the end of the week, the selling of the EUR intensified and drove the AUD higher. Whilst the AUD may well go higher and challenge the all time highs at .7735, current levels represent another opportunity at historically great value buying of EUR with AUD.

GBP/USD
The Pound Sterling came under pressure from the US dollar as the European debt driven risk aversion gained pace throughout last week. Recent statements from Bank of England officials with regards to the increasing of their quantitative easing (QE) program has provided a little further reason for the USD to outperform in the short term. Whilst they did not increase their QE at their meeting last week, analyst believe further QE is likely in the coming months as the economic outlook worsens in the UK, and certainly in neighbouring Europe. In the UK this week we have inflation numbers on Tuesday and retail sales on Thursday. In the US retails on Wednesday, inflation numbers Thursday and manufacturing and consumer sentiment numbers Friday. The primary focus will initially be the debt situation in Europe surrounding the Greek debt. Should the fear of default remain at elevated levels the US dollar will remain in demand.

GBP/EURO (EURO/GBP)
The GBP outperformed the EURO last week, albeit much of the dramatic move came on Friday as the Greek debt issues escalated and investors fled the EURO. With both central banks now deemed to be on the verge of loosening monetary policy we cannot expect interest rate expectations to provide a lead in the short term. The pair burst through the crucial level of 1.1560 (EURO/GBP.8650), so the way is opened up for further GBP appreciation. Whilst we have inflation and retail sales numbers in the UK this week, expect the focus to almost entirely be led by developments surrounding the prospect of a Greek default, and associated European bank woes that would go with this.

GBP/RAND
This pair saw mostly sideways movement for most of last week. It was not until the European debt fears really escalated on Friday, that we saw the GBP outperform the RAND. There is little in the way of South African economic data this week, so the focus will be on UK inflation numbers on Tuesday, and retail sales on Thursday. Interestingly, analyst now expect the South African Reserve Bank to maintain its record low interest rate for at least  six months in the face of still high inflationary pressure. The prospects of lower growth in its target European and US markets pointing towards sluggish conditions. Other emerging market central banks like Turkey and Brazil have even cut the cash rate last week, opting to worry about any inflationary issues once growth has returned to their economies. 

Market commentary:

The major theme of European debt inspired risk aversion, continued to play out through the course of last week’s trade.

Risk aversion reached a peak in the offshore session on Friday, as the odds on a Greek Government debt default again increased.

Markets are pricing in around a 90% chance of default from Greece, as they struggle to implement the spending cuts necessary to ensure further bailout funds from the ECB, EU and IMF.

The main beneficiary of this risk aversion has been the US dollar, as safe haven demand pushes it higher on almost all cross rates. The unprecedented Swiss National Bank (SNB) implementation of a “floor” on the EUR/CHF at 1.2000 to curb Swiss Franc strength, will have added to the US dollar demand.

Interestingly the economic numbers from China remain relatively robust, with import demand a sign that activity remains strong. The strength of the Chinese economy should offer some support for the Australian and New Zealand dollar, both of which have been under pressure, as the risk aversion has increased in recent weeks.

In New Zealand last week there was an absence of economic data, which meant direction came almost entirely from external leads. This week the Reserve Bank of New Zealand (RBNZ) takes center stage, albeit no hike to the cash rate is expected amongst the current developments offshore. The statement accompanying the decision will be closely watched for any intimation of the timing of hikes towards the end of the year. Various commentators have made calls for the RBNZ to hold fire until March or even June next year, but the interest rate market currently has around a 50% chance of a hike priced in by the December meeting.

Last week was a busy one for with economic releases in Australia. The Reserve Bank of Australia (RBA) backed up previous rhetoric by maintaining their wait and see approach to changes in monetary policy. The market saw the comments as meaning there is less chance of a cut to the cash rate in the near term, and this was AUD positive. Next came the 2nd quarter GDP numbers that were stronger than expected and the upward revision to the 1st quarter number, which also added to the positive weight. Finally the employment numbers were released and these were not as robust as expected and the unemployment rate jumped to 5.3% from 5.1% previously. This coming week is light on economic data, so expect the lead to come from developments offshore, particularly in Europe.

In the United States the economic outlook remains patchy at best. President Obama has released details of a plan to boost jobs numbers at a cost of 447 billion US dollars. There has been a luke warm response to this from the markets. The US dollar has benefitted through the problems escalating in Europe, but the potential for further quantitative easing in the US clouds the outlook for the US dollar over the medium term. Certainly momentum is with the US dollar at this stage. This coming week sees the release of the last retail sales, inflation, manufacturing and consumer sentiment numbers. All of these will be closely watched for further insight into the relative health of the US economy. In the absence of dramatic initiatives in the Euro-zone, to slow the chances of a Greek default, expect the US dollar to remain in demand, as investors seek the relative safety of the big dollar assets.

The chaos in Europe will continue this week. The German Constitutional Court ruling in favour of the legality of German bailout contributions to pressured member states did little to calm nerves as the week wore on.  The threat of credit downgrades for major European banks with Greek debt exposure, will maintain the pressure. Expect the market to remain jittery and vulnerable to quick moves. Last week the ECB left the cash rate unchanged and various European bank analysts now think the next move will be a 50 pts cut in the cash rate to 1.0%, in the coming months. The IMF have cut growth forecasts for the Euro-zone in 2011 and 2012. With so much uncertainty in Europe, it is hard to see how the EUR can rebound with any real strength in the short term. Fridays resignation of German ECB board member Stark added to the risk aversion, as tensions are obviously high at the top levels of European financial institutions.

In the UK the Bank of England made no changes to monetary policy at its meeting last week. Momentum is growing for the expansion of its quantitative easing program in the coming months and this has led to a softer Pound Sterling. This coming week sees the release of the inflation and retail sales numbers. There is potential for some the GBP support if the risk aversion continues.

In Japan efforts are being put in place to build momentum in the economy following the devastation of six months ago. The strength of the YEN remains a concern for officials, and further pressure will be felt as a result of the moves by the Swiss National Bank to curb CHF strength. Further intervention efforts can not to ruled out at some stage. The likelihood would be increased if a coordinated approach was taken by the G7 group of countries, as was rumoured to be on the agenda at meetings over the weekend. Momentum against the AUD and NZD should slow from current levels, as interest rate differentials come into play.

In Canada the Bank of Canada (BOC) left its cash rate unchanged, but its bias has certainly moved from tightening to neutral and there is little chance of any hikes coming in the next 12 months on current pricing. Employment numbers showed less jobs growth than expected, but the unemployment rate remains stable at 7.3%. This week is light on economic data, so expect the lead to come from external influences.

In South Africa the economy remains patchy. There remains widespread concerns about demand for its exports as the global growth profile is revised lower.  The South African Reserve Bank is now expected to maintain an unchanged cash rate at record lows until May next year. Interestingly other emerging market nations of Turkey and Brazil have cut interest rates, in an attempt to ignite some growth in their struggling economies. With little in the way of major economic data this week in South Africa, expect the lead for the RAND to come from offshore once again.

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Sam Coxhead is a currency analyst with DirectFX You can contact him here >>