Despite Stumble In Greek Talks, EUR Slightly Higher

 | Jun 25, 2015 03:50AM ET

• Greek talks stumble I mentioned yesterday that Greece’s creditors didn’t like the country’s proposals, which emphasized tax increases that could further dampen growth and largely ignored spending cuts and structural reforms that would boost the country’s potential. In fact, the creditors rejected the proposals and made counterproposals that Greek PM Tsipras rejected (available at http://online.wsj.com/public/resources/documents/062415Greek.pdf ). These are the “prior actions” that the government must implement and the calendar for implementation. They show that the pension system remains a major sticking point.

• To give you a feel for how far apart the two sides still are at this late date, Market News International quoted an unnamed Greek government official as describing the creditors’ proposals as “barbaric” and “Armageddon,” while a German government spokesman called them “exceptionally generous.” Given that many of the members of the ruling SYRIZA coalition thought that the original Greek proposals were too harsh, it’s hard to see how Greek PM Tsipras can come up with new proposals that the creditors will approve of and still manage to get them through the country’s parliament in time for next Tuesday’s deadline.

• The technical teams reconvened this morning at 0600 CET, while Tsipras and his counterparts from the three creditor institutions – the ECB, the IMF and the European Commission – will meet again at 0900 CET. It’s hard to imagine though what they can come up with that will win the approval of the Greek parliament. If the two sides cannot agree on measures and pass them through the Greek parliament by Sunday night, the country might have to impose capital controls, and the Greek banks might not be able to open as usual on Monday morning. That could prove to be a traumatic event for the FX markets. On the other hand, if the Greek government can agree in time, then the Eurogroup might be able to wire them the profits from the Securities Market Program (SMP) directly, which would allow them to make the payment to the IMF on Tuesday. (The ECB bought Greek government bonds as part of the SMP, which was active from 2010 to 2012. It has said it would give Greece the profits from those trades if an agreement is reached.)

• EUR slightly higher nonetheless Has this proven to be a catastrophe for the euro? Not at all. In fact, the euro was 0.3% stronger vs USD this morning than it was 24 hours ago, while the Deutsche Bank (XETRA:DBKGn) EUR TWI was up 0.37% this morning compared with its Tuesday close. The range in EUR/USD was 0.74% yesterday, well below this year’s average of 1.23% (although this is the European trading day, which ended before the talks officially blew up). It looks to me like market participants are simply getting bored by the whole Greek issue and are thinking about other things, such as their plans for this summer. The main impact was on the stock markets, not the FX market. FX is being more influenced by monetary policy, and USD was mixed, as Fed funds rate expectations slipped somewhat and UST yields declined. That may be the channel through which Greece is affecting the FX market: increased Greek tensions reduce the likelihood of Fed tightening and thereby paradoxically weaken the dollar, not the euro.

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• Nonetheless, I still believe that the failure of the talks would be negative for the euro. Investors are starting to worry about the possible contagion effects, notably on Portugal. After falling to record lows in recent months, Portugal’s borrowing costs last week hit their highest point this year as the Greek tensions increased. During the previous Greek crisis in 2012, Portuguese 10-year bond yields soared to 18%, forcing the-then government to seek a rescue from the EU and the IMF. UBS has forecast that Portugal’s borrowing costs could double if Greece leaves the euro. Even before that, if Greece imposes capital controls, depositors in Portugal could worry that they may be next and start to move money abroad. That could impose serious strains on the European monetary system, weakening the euro.

Today’s highlights: During the European day, EU leaders begin their two-day summit. Greece is likely to dominate the discussion; however, the fast-approaching UK referendum on EU membership will also be among the key points of the summit. This will be the first time that the UK PM will officially present his demands as part of plans to renegotiate UK’s membership with the EU. He will seek to get support from the EU leaders for reforms meaningful enough to persuade the British people to vote to remain in the EU. Anything that could undermine the UK’s membership in the bloc could have negative impact on GBP.

• As for indicators, only data of secondary importance are coming out: Germany’s GfK consumer confidence for July and Sweden’s PPI for April. Neither is a major market mover.

• In the US, we get personal income and personal spending for May. Both are forecast to accelerate, but the market will most likely focus on personal spending, which is forecast to rise sharply after a flat reading in April. A big pickup in spending will support a rebound in growth in Q2, and add to the likelihood of a rate hike in September. The yoy rate of the PCE deflator and core PCE for May are also coming out. The PCE deflator is expected to accelerate, while the core PCE is forecast to remain unchanged in pace from April. The former could add to dollar’s strength. The preliminary Markit (NASDAQ:MRKT) service-sector PMI for June and initial jobless claims are also due out.

• As for the speakers, Swiss National Bank President Thomas Jordan and Fed Governor Jerome Powell speak. Powell spoke Tuesday on monetary policy, while Thursday, he speaks on payment systems, so his comments are not likely to add much to our understanding of Fed thinking.

h3 The Market/h3

h3 EUR/USD trades somewhat higher/h3