Analyst Interview: John Kicklighter on Greece, the ECB and QE3
1.) Is a deal on Greece's second bailout already priced in the markets? Will the focus move to Portugal?
It is impossible to fully price in the outcome of the Greek situation. It is simply too complex. When we have big reactions to event risk, the change in price is the adjustment to the new ‘fair value’. When we didn’t see significant development coming, we get the biggest market reaction. Should we know what is coming – but not the exact outcome or timing – the impact can be significant though it is usually not as dramatic. The missing components here are what exactly will be done for/to Greece and when will it happen. The leading consensus now is for the private debt swap to happen with a 70-plus haircut and low yield that will advance the second public bailout which requires more austerity. Having everything line up for a Greek private and public rescue wouldn’t be as market moving as failure considering that eventual optimistic outcome is expected (and is significantly priced in with the current ‘bid for time’ effort). Yet, there are so many moving components here that failing to meeting a reasonable solution by March (when their next bond payment is due) is a serious risk. Making special accommodation to just pay that tranche to carry this forward would probably permanently lower confidence in the euro’s position. Caving to default calls would have the greatest impact in this scenario with a euro tumble – though this possibility would not be too shocking to a significant portion of the market (and therefore wouldn’t carry a multi-month bear trend). As for Portugal, the worse the situation for Greece; the more attention the fellow bailout member will attract. Greece will likely remain the critical denominator in this equation until it is receives absolute support or succumbs to default.
2.) Do you expect Mario Draghi to introduce new policy measures to help the euro-zone economies, such as a rate cut or any another policy measure?
If the time frame for this view is 6 to 12 months, then absolutely. Should our outlook period be limited to just this upcoming policy meeting, the probabilities are much lower. Heading into the February central bank decision, the market (overnight rate swaps) is pricing in approximate 55 percent chance of a 25bp rate cut. That said, the 12-month forecast isn’t pricing in a full, quarter-percent cut and the economist consensus is for a stay at 1.00 percent. That degree of variability in the outcome could be good for a moderate reaction to the outcome. An actual change to the benchmark would carry the most influence, but the commentary that sets the tone for future policy decisions is just as important. Given the improvement in regional sovereign bond yields and liquidity measures over the past month, Draghi and company will likely keep the wait-and-seen character in the statement and answers. Announcing an abnormal policy change would be quite remarkable for the ECB (in other words, it would probably require severe strain). The central bank has already implemented the first LTRO program and will do the second at the end of this month. They are also buying up government debt without targets or an objective (all the while saying it is not a QE effort like the Fed’s or BoE’s).
3.) Do the excellent job figures close the case for a QE3 in March? Or is it still on the cards?
The payroll figures for January were encouraging but far from definitive for the US. A slowdown is still coming, and that will subsequently curb employment trends. However, when it comes to time frames for the possible adoption of QE3, the jobs figures will almost certainly help to push another program further out. The February labor report (due March 9th) could reverse the sense of good will before the next Fed meeting (March 13th) of course. Yet, it would be a combination of a negative outlook for employment and housing trends alongside a renewed market-wide financial pressure that would most likely instigate that next easing effort. This is always a probability, but it would be more difficult to hit this level of trouble between then and now (unless the European situation is in a nosedive). Furthermore, the Fed is on a transparency kick, so we would likely see such a move coming ahead of time – allowing the market time to adjust.
4.) In the last expansion of Britain's QE program, the pound's fall was quite short lived. Do you think it will have a limited effect this time as well?
The bond purchase program is a remarkable size at its current (pre-February BoE meeting) level of 275 billion sterling. Yet, the once severely market-moving policy announcements by the central bank are far reduced nowadays. Part of this comes via the transparency. Another aspect of this lack of impact though is the relative conservatism of the program. Holding to a clearly defined program of government debt purchases spread out over months holds a much smaller surprise-quotient as compared to the ECB or Fed moves. That said, we have seen the sterling weighed for the MPC expansionary ways over time. GBPUSD has been unable to advance meaningfully from its 18-month low range low. EURGBP is still well off its consistent range pre-2008 (nearly 1,500 pips lower that where we trade now). GBPAUD, GBPNZD and GBPCAD are chopping around record lows. This is a good sign of the long-term impact that meaningful fundamental changes can have without the short-term bursts that the unknown often generate.
5.) The Canadian dollar eventually ignored weak domestic growth and job figures, and jumped on the good surprise from the US NFP. Do you see this as a coincidence? Or is the Canadian economy's dependency on the American one likely to be strongly reflected in currency movements in the near future?
The Canadian dollar is in a unique position. It groups easily with the carry / investment currencies (Australian and New Zealand dollars) when we line it up against currencies with a low or ambiguous position in the yield spectrum. At the same time, the economy holds a significant dependence on its US neighbor to fuel growth. This can work out to be quite the boon under many circumstances. That said, it also leverages the pain when the dollar draws benefit from a global financial and economic slide that hits the US itself – forcing capital to the most liquid of assets (US dollars and Treasuries). There isn’t really a coincidence to the Canadian dollar’s recent performance therefore with risk and equities up on speculative interests while US consumption also seems to still be on its upward trajectory.
--- Answers provided by John Kicklighter, Senior Currency Strategist for DailyFX.com for an interview with Forex Crunch.
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