Are markets becoming de-sensitized to Greek woes?

After the markets ended last week on a high, news from credit rating agency Standard & Poor’s that the plans being discussed with European financial institutions to roll over Greek debt would constitute a default took the shine off risky assets this morning.

The rollover plan would see holders of Greek debt that matures by 2014 only receive 30 per cent of their money back and 70 per cent rolled over into new 30-year Greek bonds. This 'voluntary' plan has been accepted by German banks to the tune of more than €2 billion and has been accepted with even more gusto by French banks even more exposed to Greek debt.

If the banks are 'happy' to rollover their Greek debt then why are the credit rating agencies not playing ball and threatening to downgrade Greece to  D? This is because any change to the bond’s indenture or terms and conditions is “technically” a default, especially when it concerns the delayed payment of funds. This move by S&P has already irked the financial community who have accused S&P of being too technical with the issue of whether or not to downgrade Greece to default.

Right now the markets seem to be fairly resilient to the S&P’s warning. EUR/USD is close to one-month highs above 1.4500, only dropping 50 points on the news. Stocks are flat to slightly higher since the European open and the dollar is fairly flat. The Vix index, a good gauge of Wall Street’s appetite for risk, remains at a very low level. However, we would warn against investors becoming too complacent about the Greek debt crisis and the possible ramifications of a Greek default. The southern European nation is not out of the woods yet.

Greece may have bought itself some time and staved off a default for now after securing its next tranche of bailout funds from the EU/International Monetary Fund and European Central Bank (ECB) on Saturday night, but Athens still hasn’t secured a second bailout and we don’t know if the EU will be able to persuade credit rating agencies not to revise Greece’s sovereign credit rating lower on the back of the private sector debt rollover plan. So this rally in risk is built on shaky foundations in our view.

There are three main drivers of the single currency right now. Firstly, the removal, at least in the short-term, of a Greek default, secondly the weakness of the dollar and thirdly the ECB’s determination to hike rates and stamp out inflation pressure even if the peripheral economies are still struggling.

The markets have fully priced in a rate hike on Thursday from the ECB, but investors will be more interested in the press conference afterwards. They will be listening out to whether Jean-Claude Trichet [ECB president] sounds hawkish and ready to raise rates again before December when the markets expect another hike, or if he sounds worried about: one, the potential for Greece’s credit rating to be downgraded causing financial market turmoil and something the ECB has wished to avoid; and two, whether or not the Bank is worried about a more profound slowdown in growth.

Data out of the Eurozone today was mixed, consumer confidence fell to an eight-month low, although it was stronger than expectations and producer prices fell slightly, although they remain at elevated levels. In the UK the PMI construction survey was weaker than expected. Although the fundamental outlook continues to deteriorate for the UK, the pound has bounced after falling below 1.6000 last week. Although we are not constructive on the outlook for the pound, we believe we won’t see sterling weakness until the dollar starts to recover which may not happen until the fourth quarter. However, the pound remains weak against the “strong” currencies like the Swissie and the yen, and even EUR/GBP is close to 18-month highs.

Although it’s the Independence Day holiday in the US there is a lot for investors’ to think about. We are worried that investors are becoming too complacent about risk, and we could see a reversal in sentiment. However, we don’t think that will happen in the near-term. Stocks, the euro and commodities are all moving higher partly in response to the weaker dollar. In the current environment where Congress is wrangling over raising the debt ceiling, growth is weak and the US’s debt burden continues to increase then the dollar will find it hard to stage a true reversal. The greenback is still doing fairly well during periods of risk aversion, but on balance it remains very weak, which is acting as a support to risk.

Elsewhere, USD/CNY closed at a fresh record low below 6.4950 earlier, which has also helped boost risky currencies. Usually this helps the Aussie dollar; however, it has failed to break above 1.0750 after some weak retail sales data. The Reserve Bank of Australia (RBA) meets tomorrow and is expected to keep rates on hold at 4.75 per cent. There is a risk that the RBA governor may be hawkish on inflation after Chinese prices rose strongly last month. Since China is Australia’s largest trading partner, price pressures in the Asian powerhouse could threaten Australia.

Kathleen Brooks is research director at Forex.com

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