We the People
By Zach Berg, CFA
June 18, 2012
“We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America.” – United States Constitution
The Preamble to the U.S. Constitution serves as an exemplary representation of what nearly all democracies hope to achieve through government and serves as a very apropos theme as voters from Greece, France, and Egypt took to the polls this past Sunday. In Greece, the birthplace of democracy, after waiting six weeks since the last failed election attempts on May 6th, last night’s results indicated the New Democracy (pro-bailout) party received the greatest numbers of votes at approximately 30%, followed by Syriza (anti-bailout) at 26.5% and Socialist Pasok (pro-bailout) at 12.5%. Although New Democracy failed to win enough seats for outright control of Parliament, the formation of coalition government with the Socialist Pasok party is seen as a very likely scenario. The market’s reaction had been an initial bout of joy, which has subsequently soured as the Euro popped higher only to retrace lower in overnight trading, while Treasury yields actually have marched lower as opposed to the sell-off some had thought might transpire given a New Democracy win.
In overnight trading, risky assets received an initial pop which should not have been surprising as many viewed Sunday’s Greek elections as a vote on EU membership and a Syriza victory as a step towards an imminent Greek exit. However, perhaps Sunday’s election should have rather been viewed as whom the Greek’s would like to renegotiate the current bailout terms. Heading into the elections both party leaders of Syriza and the New Democracy had stated they would look to re-negotiate the current program with Syriza taking a “bull in the china shop approach” of blowing the old program up, while New Democracy leader Antonis Samaras stated he would look to cut certain taxes without reducing spending. Those changes are still at odds with the current memorandum. Bloomberg is reporting that European governments may be willing to allow more time for Greece, as they did for Spain, to implement their proposed cuts on the quick formation of a government. This relenting is likely the result of another set of news stories that Greece only has enough cash to survive though mid-July. This cash burn highlights just one of the many issues remaining for Greece on what may be an extremely difficult road ahead. First, the Greek’s have thus far failed to successfully implement many of the proposed reforms agreed to in the previous Memorandum of Understanding negotiated in February 2012 and the lack of government for the past six weeks has only delayed those efforts even further. Additionally, the Greek economy is performing worse than expected, perhaps leaving the combination of the International Monetary Fund (IMF), the EU, and European Central Bank (ECB) little choice than to relax the current program or face an eventual Greek EU exit anyways.
As Greece looks to hang on, the political brinkmanship between France and Germany looks primed for a clash. The French Parliamentary election results, also held Sunday, may have the potential to shift the previous dynamic in which France and Germany worked on a unified front to press for harsher austerity measures at the wishes of Germany versus pro-growth policies. French President Francois Hollande will awake Monday morning to the realization that his Socialist Party has a strangle hold on French policy after winning an absolute majority, allowing him to put through legislation without the votes of any other opposing party. A Socialist Party representative was already quoted on Sunday evening via Bloomberg stating that their, “large majority will allow us to lead the battle for growth with our European partners against the politics of austerity.” Not exactly the comforting words Germany’s Angela Merkel would like to hear.
Even now that the fears Greece would abruptly leave the EU, creating a death spiral for the entire union has been assuaged for the time being, the market backdrop remains one with numerous variables and plenty of uncertainty. Remaining in Europe, Spain has become a much greater concern than Greece. The previous week’s announcement of a €100 Spanish bank bailout did not receive a positive market reaction as a lack of details, Spain assuming the debt burden and concern over bondholder subordination pushed Spanish 10-year yields above 7%. Those same 10-year yields are now back above 7% in early Monday morning on the reports that Spanish banks percentage of bad loans rose to 8.72%, marking its highest level since April 1994. This upcoming week should see the release of a bank report detailing the amount of capital Spanish banks require, as speculation swirls that the amount may be 50% more than previously thought. Next week’s European Summit (June 27th-28th) will be very important, as the reaction to Spain’s bailout displays a growing discontent amongst investors. They have witnessed this story before of a sovereign failing to meet deficit targets, eventually being unable to raise funds in the secondary markets as their yields skyrocket, leading to a full-blown sovereign bailout. Many will be watching to see whether policy leaders can form a consensus on establishing the ECB as the chief systemically important bank regulator (supported by France), while altering rules to allow the European Stability Mechanism to recapitalize the banks that need funds.
Domestically, the Fed retakes center stage with the FOMC rate decision scheduled for this Wednesday at 12:30pm, followed by a Bernanke press conference at 2:15pm. Last week’s economic data continued to disappoint leading the Citigroup Economic Surprise Index to its lowest level since early August of 2011.
How will the Fed respond to the dampening in economic data is the million dollar question this week? Outlined in previous Bond Market Commentaries, the hurdle rate for more full blown large scale asset purchases has not appeared to have been cleared yet as inflation expectations still remain above levels corresponding to action. On the other hand, the Fed could provide a temporary reprieve to further easing calls by extending its Operation Twist program; however, the Fed currently only holds enough securities in the 3-month through 3-year portion of the curve to continue the current program for 3-4 months. Lastly, the Fed could do nothing, leading to the potential of a huge disappointment. Thus the bias for the direction in Treasury yields and spreads of corporate, mortgage-backed, and agency remains tricky to assess with such great amount of variables still at play. Barring some policy action it appears that risk is remaining in the “off” position to begin the week, which is helping provide a bid to Treasury yields, while corporate spreads leak wider. Sunday’s Greek elections, although built up in the preceding weeks, are appearing to be much to do about nothing as investors acknowledged the world will not end and are now refocusing on the multiple other problems overhanging these markets. The hope now for investors domestic and abroad is that their governments, elected or otherwise (The Fed) can find a way to promote some investor welfare and perhaps provide some much needed market tranquility. If the recent past is any indication of the future, one has learned to not hold their breath.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
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