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Tuesday April 13, 2010 - 17:30:41 GMT
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Greek Bill Auction “Successful”

I use quotation marks simply because this is not the market at work buying up attractive Greek government bills in some profit maximizing effort.  Rather this is a highly distorted market with the not so invisible hand (foot and body) of government involvement and selling E1.56bln in short-dated paper with an implicit EU backing and when the paper is acceptable as collateral at the ECB lending window (rules relaxed to allow for this), there is little the market did to allow for this auction to go 5-6 times oversubscribed.  Why would any bank pass on an opportunity to earn nearly 400bps in spread picking up this paper at auction and have the ability to post these bills with the ECB for funds?  I have not seen the data on this but I would suspect that the banks (local and EZ wide) would be all over this auction making direct bidding large part of the auction. 


What is most important about today’ auction is the price it sold at and this was a little under 5%, well down from the 6-7% high in yield reached last week in Greek bills.  Considering in January the Greek government could borrow short-term at well under 2%, this is no way for a cash strapped state to financing a relatively enormous budget deficit.  And rather than viewing this as a sign of success as Chancellor Merkel asserted today, I see it as a sign of an unsustainable fiscal train wreck.  Because Greece can’t devalue its currency and improve competitiveness, it has to slam on the fiscal brakes, adding deflationary pressures to an economy already shrinking at around a 2% pace this year (Greek government’s own forecast).  An all the EU and IMF have pledged is around E45bln in loans at rates that are far from where the rest of the EZ borrows.  Considering Greece has around E53bln in debt to sell this year, which leaves Greek financing for 2011 in doubt assuming Greece seeks aid this year in total. (we think it is a matter of when not if). 

BlueGold’s Stephen Jen (DJN) calculated what the EU would need to extend the same terms (bailout size) to the rest of Eurozone’s Club Med and the loan program would rise to E465bln (including Greece) and that would cover roughly one-year’s borrowing need…this also assumes a black swan outcome for the rest of Club Med which Jen does not think likely. 

Even if we assume that Greece and the Eurozone muddle through this crisis and Greece avoids default (taps the rescue mechanism), there should be permanent damage to the EUR…Greece has exposed 2 key flaws in EMU…monetary union without political union and economic divergence with one monetary policy (interest rate and exchange rate).   I don’t forecast a Greece default, just a rising cost for Eurozone for keeping Greece in EMU.  And there is every reason to think in time that other Club Med members get a similar treatment from investors requiring an extension of the EU support mechanism even if in a reduced form. 


Don’t confuse ongoing reserve diversification from the likes of the Korean and Malaysian central banks (buying euros) with a bottom in the single currency or a vote of confidence in the Greek fiscal outlook, post EU support mechanism.  While everyone is tired of looking at Greece for direction in FX trading, this story is far from over.  Other fiscal train derailments are possible in Club Med ahead as well as all members move to rein in fiscal deficits to meet 3% Maastricht deficit/GDP ceilings by 2011.  Tighter fiscal policy across the Eurozone means the ECB will keep rates low longer and frankly may have to cut rates more from 1.00% now.  Again this is a reason to short EURUSD (EUR high yielders too). 


Frankly I think the EUR sells off again ahead when Greece is forced to request aid from the EU…something Germany believes will require a unanimous vote from EU Summit while others assert no such approval is needed…only need request.  The Keystone Kops approach to helping Greece seems to be unending.  Another constraint that could make for some interesting times ahead is the May09 election in North Rhineland-Westphalia which is the most populous state in Germany and a loss for the CDU and Free Democrats (Merkel’s coalition) would end the government’s majority in the upper house (Bundesrat).  In other words Greece has surely been told by Merkel not to request help until after the state election. 


With Greece’s USD bond offering in the works for a mainly US audience this month, we may get a better sense of how much end investor demand there is for Greek paper (no posting of USD Greek bonds for collateral at ECB by the likes of PIMCO and Blackrock for instance).  And for that matter both PIMCO and Blackrock portfolio managers have said they would likely steer clear of the issue leaving who? 


Sell the market with a 1.37 stop and goal of 1.30.


David Gilmore




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