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Beggars Can't be Choosers - Weaker Data, Greece and MF Global Killing Risk

Kathy Lien, Director of Currency Research, GFT

Beggars can't be choosers and the fact that Greece even thinks they have a choice in accepting the EU debt deal is beyond logic. For the past month, European leaders took on the hard challenge of crafting a broad rescue plan for the region and convincing bond holders to voluntary accept a 50% haircut on Greek debt. Everything was going well up until yesterday when Greece decided to throw a big wrench into the EU's rescue efforts by announcing a referendum, sending currencies and equities sharply lower. The problems were escalated by the demise of MF Global, which served as a harsh reminder to investors of how leveraged sovereign bets can go wrong. Manufacturing data from the U.S. and China were also disappointing because they provide evidence of slower global growth. The manufacturing ISM index fell from 51.6 to 50.8 in October, with deterioration in prices, production, employment and inventories. Prices contracted at its fastest pace since May 2009, adding to the case for more stimulus from the Fed. At this point, there are so many factors working against risk appetite that the path of least resistance for euro remains lower while the U.S. dollar and euro remain in demand. MF Global is not the only financial institution to take sovereign bets but hopefully they are the only ones with such sloppy internal controls.

We can leave it to the Greeks to cause more trouble for Europe and the financial markets. Neither Greece or the Eurozone can handle a no vote and the only rational reason for holding the vote would be if the Prime Minister felt certain that his citizens would approve the deal. Unfortunately with 60 percent of people surveyed in a local poll opposing the deal, it has a greater chance of being rejected than accepted. The reason why a referendum has been announced is obvious - the Greek Prime Minister doesn't want to be pushed out of office and wants to appear that he cares about the opinions of the Greeks. But now is not the right time to play political games particularly when a no vote could mean an outright default. 

Although the sell-off in the EUR/USD clearly indicates that risk appetite has taken a sharp U-turn, the widening of Italian-German and French-German 10 year yield spreads shows how serious the concerns have become. Both Italian-German and French-German 10 yr yields spreads have widened to record levels, meaning that investors believe the risk of investing in Italian or French bonds versus German bonds, which are considered the safest fixed income investments in the Eurozone is higher than where it was back in October, when Greece was at the brink of default. By deciding to hold a vote on the EU debt deal, the Greeks have erased months of hard work by EU leaders and restored the market's fears about contagion for Italy and France. This makes this week's G20 meeting all that more eventful. Originally, the G20 Summit was expected to be a nonevent with the EU debt bringing stability to the markets - now that uncertainty is once again at escalated levels, the G20 may be forced to offer support to the markets verbally or physically. 

We have already seen evidence of central bank officials succumbing to the pressure of European uncertainty. The Reserve Bank of Australia cut interest rates by 25bp last night and even though they attributed the cut to the prospect of lower inflation, we are certain that the volatility in the markets have played a role, with the RBA feeling compelled to take an insurance cut. Thousands of investors in Australia have been affected by the destruction of MF Global and the rate cut will help ease some tensions in the local banking sector. The return of volatility could also encourage the European Central Bank and the Federal Reserve to take similar measures to ward off recession.