Why has the rally in the EUR been so lackluster? Because there are a still 4 3 more hurdles to overcome before we can put the Greek debt crisis behind us.
The Greeks have jumped over 2 hoops on their own with one more expected to be cleared once the Greek implementation vote is completed this afternoon.
1. Win no Confidence Vote
2. Get Parliament to Approve Austerity Plan
3. Get Parliament to Approve Implementation Procedure
4. Get EU/IMF to Release Next Tranche of Aid
5. EU/IMF Needs to Come up With a Second Rescue Plan for Greece
6. Rating Agencies need to be convinced that the Rescue Plan does not constitute a default
The Greeks have lived up to their end of the bargain by passing the Austerity Package that the EU and IMF demanded and now the ball is in their court. When European Finance Ministers meet on July 3rd, we expect them approve the next bailout tranche, worth EUR12 billion. They will then start to discuss options to ensure continued financing for Greece. Thankfully, investors are not operating in a vacuum because the bond rollover plan proposed by France has received widespread approval and support by the markets. Getting rating agencies to feel the same way will be the main challenge but crafting the second bailout package will not be easy either because even if there is enough participation in the rollover, Greece will still be asked to find buyers for EUR50 billion worth of state owned assets.
The EUR/USD ripped higher after ECB President Trichet telegraphed a possible rate hike next month. The rise in oil prices has hit a cord with the central bank, prompting them to step on the accelerator and get moving with curbing inflation pressures. Not only did Trichet use the magic words “strong vigilance,” but to remove any uncertainty, he said point blank that “Vigilance means rates may rise next month , increasing rates in April meeting possible.”
Regardless of how much Trichet tried to tone down this comment later on by saying it is not appropriate to expect a “big rate move,” and they are not ready to embark on a “series of rate hikes,” the mere prospect of a rate hike is very positive for the euro. Even if the EUR/USD does not take out 1.40 today, it should just be a matter of time before it does so. Based upon Fed Chairman Ben Bernanke’s comments earlier this week, the U.S. central bank is still straddling the fence in terms of normalizing monetary policy. In contrast, the ECB has sent a very clear signal to the market that rates will increased over the next 1 to 2 months. This dynamic should cause the dollar to continue to underperform against the euro.
The race is now between the ECB and BoE and the way its looking, the ECB could be the next central bank to raise interest rates. The central bank upgraded its inflation forecast for 2011 to 2.0 – 2.6% from 1.3-2.3% forecast in Dec and their 2011 GDP forecast to 1.3-2.1% vs. 0.7-2.1%.
Down baby, down. Who said 1.30 is not possible (Not me – Bearish euro calls)? Trouble begets more trouble. As I said on my twitter feed twitter.com/kathyliefx no one wants to own euros. Irish, Portuguese and Spanish 5 year CDS spreads have all widened (What are Credit Default Swaps?). I expect more rating actions that will spook investors from owning euros. The next should be Standard & Poors who currently rates Ireland an A, 2 notches higher than Fitch and Moody’s. European government officials are so concerned about these recent rating actions that they are stepping up their efforts to stabilize confidence – the ECB announced this morning that they will establish a swap line for Ireland in case they need it. Watch for more downside in the EUR/USD!