Euro Closes Gap, Don’t Expect Much from G20

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As it turns out, the winner of the Greek elections did not matter. The victory of the pro-euro, pro-austerity New Democracy Party did not change the outlook for the EUR/USD which closed its gap and is trading lower than where it ended on Friday. Of course, a win by the Leftist party would have left policymakers with a big mess to clean up today, but the initial enthusiasm after Samaras’ win faded as investors realize that the Eurozone debt crisis is far from over. The 7 percent yield in Spanish 10 year bonds is a wake up call for Europe. While the crisis in Greece has been contained for the time being, the problems in Spain have exacerbated as a rescue for the country’s bank could quickly turn into a full sovereign bailout. It is under this backdrop that G20 leaders hold their meeting in Mexico but as much as we would like to see a major announcement post meeting, the outcome of the Greek elections eliminates the immediate risk of a Grexit and the need for an emergency response. For this reason, we don’t expect much from this week’s G20 meeting which has begun and will end on Tuesday.

In fact, this could turn out to be a week filled with disappointments. A Samaras victory was the best-case scenario for the EUR/USD and risk appetite but unfortunately the euphoria was short-lived as shown in the chart below. We expect G20 leaders to only confirm the increase in the IMF’s rescue fund that was decided back in April and for Federal Reserve to extend operation twist (What is Operation Twist?) and put off QE3 for the time being. A coordinated rescue plan could still be in the works but the catalyst will now be Spain and not Greece. The biggest risk for the EUR/USD is no longer a Grexit but a full-fledged Spanish sovereign bailout.

Don’t Expect the IMF to do More Than Confirm IMF Recapitalization

With eurogeddon averted for the time being, G20 leaders can breath a sigh of relief, but don’t expect them to spend all of their time lounging at the pool and swimming in the beaches. Finding an immediate solution to Europe’s problems has become no less critical because the rise in Spanish bonds yields tell us that the Europe’s debt is far from over and the threat to financial markets remain. President Obama, whose election bid will be crushed by a deep collapse in the market will try to convince German Chancellor Merkel that an aggressive response to Europe’s debt crisis benefits everyone. If the anti-austerity Syriza party won the Greek elections triggering a sharp sell-off in the markets, expected tougher words would come out of the G20 but the New Democracy victory means that we can’t expect anything more from G20 leaders than a confirmation of their pledge to recapitalize the IMF. With Spanish bonds topping 7.25 percent, these funds could be needed quickly. Two months ago, G20 leaders agreed to increase the IMF’s war chest by $430 billion. China has already committed to be a big lender and the EUR/USD will rally if the funds contributed exceed $430 billion. However with the U.S. keeping its pocketbook closed this round, the contribution could fall short of target which would be killer for the EUR/USD. Growth and job creation measures will also be discussed and everyone will agree that more growth and jobs are needed.

The real work to be done will be at the June 28-29 EU Leaders Summit and what the world wants is a timetable for a fiscal and banking union. The risk of euros have not been eliminated by the best case outcome of the Greek election and the for the time being the EUR/USD will move tick by tick with Spanish bond yields as shown in the chart below. The U.S. economic calendar is completely empty today but there’s certainly no shortage of volatility in the currency market.

EUR/USD to Move Tick by Tick with Spanish Bond Yields

Kathy Lien
Managing Director

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