Grexit Threat Returns as Investors Bet on Greek Default

The Forbes

APR 16, 2015 @ 3:46 PM 671 VIEWS

Dollar bulls are retreating on Thursday after the greenback struggled for traction against several currencies, and investors are increasingly betting on Greece exiting the eurozone in the not-too-distant future.

Global yields continue to tumble, mostly on fear or lack of returns and modest growth prospects. It’s beneficial for investors to understand the relationship between various yields spreads to comprehend some of the recent currency moves. The rule of thumb is that a low rate environment does not make a currency attractive to investors. One only has to look at the relationship of the EUR to the U.S.-German 10-year spread; it has been correlating well with EUR moves of late. Judging by the moves after the March Federal Open Market Committee meeting minutes and nonfarm payrolls data was released, the market has been selling EUR strength. When the spread widens EUR sellers tend to appear. The problem this week is that the market focus has been on lower U.S. yields being backed by weaker data.

Nevertheless, the dollar continues to soar above the EUR in anticipation of the Federal Reserve preparing to raise interest rates later this year or early next, in contrast to the European Central Bank (ECB). With the ECB committed to buying €1 trillion in bonds until September 2016 — restricted to assets that yield more than the ECB’s deposit rate of -0.2% — it’s no wonder that there is a feeding frenzy for European product all along the curve. German bunds continue to smash through record high prices or record low yields, using the ECB demand as their backstop.

It’s not just the ECB, but also Grexit (read: Greece exiting the eurozone) fears that are driving German yields lower. Greece bonds are under pressure again this morning on the back of lowered market expectations over any forthcoming reform proposals. This is raising the prospect of a possible default on May 12 when €747 million is due to the International Monetary Fund. The fear factor is blowing out Greek-German spreads again, back to their March highs (+1225 basis points). With German government debt considered to be some of the lowest risk globally, it’s only natural that they are in high demand. Yesterday, S&P Ratings slashed Greece’s debt deeper into junk territory, saying it expects the country’s debt and financial commitments to be “unsustainable without deep economic reform.” This has pushed the yield on Greece’s 10-year bond to +12.3%, while the yield on its two-year bond has ballooned to +25.3%. The inverted curve (short-term yields are higher than long-term yields) would suggest that the market is now betting heavily on a default.

This has been the cue for investors to try and smash the EUR/crosses lower this morning. EUR/CHF was driven lower through stops under €1.0290 on risk aversion. EUR/AUD and NZD has been sold by models post-Aussie jobs data, while EUR/GBP has dropped to test new monthly lows around €0.7160 with sterling being used as a relative safe-haven play. The hopeful sellers will have to wait and see if this market squeeze can build further momentum.

It seems that commodity currencies like the CAD ($1.2286) and the AUD ($0.7780) finally have lives of their own. Up until yesterday, the pair had been sucking wind for a while, trading in a relatively tight range with investors suffering whiplash price effects. The loonie came to life not from the Bank of Canada rate announcement or monetary policy forecasts, but from the price of crude. May West Texas Intermediate crude oil was up over +5%, rising above $56 a barrel for its highest level of the year, and also testing the 100-day moving average for the first time in about eight months. The demand for crude has been supported by smaller-than-expected inventory data from the U.S. Department of Energy as well as the American Petroleum Institute. The loonie, as the Canadian $1 coin is known, subsequently took flight, aided by the dollar being weighed down by disappointing U.S. industrial production data.

The CAD dollar’s other commodity-sensitive and high-yielding cousin, the Aussie dollar, has found much needed support on the jobs front. In the overnight session a particularly strong employment report Down Under (+37,700 versus +15,000 expected; unemployment rate +6.1% — a three-month low) has sent AUD/USD to a new two-week high this morning. While the data has been volatile, the seasonal adjustment in this month’s figures would suggest that the Aussie labor market unease could have been overstated. Going into the release, fixed-income markets priced in about a +70% chance of a Reserve Bank of Australia (RBA) rate cut next month, but after the announcement, that probability has slid to just under +56%. The market will now focus on next week’s quarterly inflation report for conviction. Remember, the RBA has been very vocal in talking its currency down, deeming it overvalued. It would not be too much of a surprise to see the RBA cut instead.

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