Overnight Summary: The "Hope" Is Back, However Briefly

Those looking for fundamental newsflow and/or facts to justify the latest bout of overnight risk exuberance will not find it. To be sure, among the few economic indicators reported overnight in the Thanksgiving shortened week, European construction output for September tumbled -1.4% from August, after rising 0.6% previously. How long until Europe copycats the latest US foreclosure sequestration, "demand pull" gimmick and gives hedge funds risk free loans to buy up housing (aka REO-to-Rent)? More importantly, and confirming that Spain is far, far from a positive inflection point, Spanish bad loans rose to a new record high of 10.7%. This was the the highest level since the records began in 1962. The total value of these loans was €182.2 billion ($233 billion) in September, according to the Bank of Spain (more on this shortly). The relentless rise indicates that the Spanish bad bank rescue fund will be woefully insufficient and will need to be raised again and again. So while there was nothing in the facts to make investors happy, traders looked to hope and prayer, instead pushing risk higher on the much overplayed Friday "news" that politicians are willing to compromise in the cliff (which as we reported was merely a market ramping publicity stunt by Nancy Pelosi et al), and that Greece may be saved at tomorrow's Eurogroup meeting, for the third time. That this will be difficult is an understatement, with the Dutch finance minister saying no final decisions on Greece should be expected, and his German counterpart adding that a Greek debt writeoff is "inconceivable." In other words, even hoping for hope is a stretch, but the market is doing it nonetheless.

But if it is inconceivable to cut Greek debt on the public funds side, and a bond buyback for the private sector is improbable (as reported previously), what is the basis for Greek hope tomorrow? There is a loophole as SocGen explains:

Speaking over the weekend, Bundesbank President Weidmann also pointed to the moral hazard of offering Greece debt forgiveness (something he believes will ultimately be needed) today. His suggestion was to offer Greek conditional debt forgiveness, once the agreed austerity measures and reforms are implemented. The conditionality holds political appeal, but this involves handing over taxpayer money to Greece (so far, only private money has been lost).


A neat twist on the idea would be to allow the ESM to take over Greek bank recapitalisation (around €50bn or 25% of Greek GDP), placing responsibility for any losses on the Greek government, until austerity and structural reform are agreed. This solution would hold several advantages. First, the amount is large enough to secure general government debt below 120% of GDP by 2020 on paper. Second, it involves no unpalatable debt forgiveness. Third, it could easily be replicated for the other programme countries. Fourth, it would break the sovereign-national banking sector link. The question remains, however, whether such a solution can be introduced before the single supervisory mechanism is in place. Combined with the idea of using ECB profits from Greek government bonds of just under €10bn to buy back Greek bonds, the final outcome could be a debt reduction to the tune of 45% of GDP. Sadly, this would still not be enough in our opinion to make Greek public finances sustainable in the long-term.

Obviously, the important section is bolded: once again it is obvious that nothing can help Greece save a Grexit, but in the meantime, the Greek people will be bled some more, with what little wealth remains in Greek society, transferred to European banks, and what little assets remain in Greece, encumbered with further bank liens.

What else is on today's macro agenda:

Political uncertainty will be one of the major forex and rate themes for the G10 this week.


First Japan. The dissolution of Parliament has opened the door to elections on 16 December. Although Prime Minister Noda plans to present a new set of measures to boost the economy by end-November, will that be enough to keep the DPJ in power? Nothing is less certain. The LPD appears to be well placed to win, against growing pressure on the BoJ to ease monetary policy further and weaken the JPY. This political uncertainty could weigh on the JPY over the very short term, particularly as the Japanese trade balance, published this week, is expected to be negative again, unless the geopolitical situation in the Middle East worsens and risk aversion cuts short the rally in G10/JPY. That is the main risk.


In Europe this week, an extraordinary Eurogroup meeting will be held Tuesday on Greece. Will the EU and IMF reach an agreement on how to finance the 2Y loan extension to Greece? We should have the answer on Tuesday, or at the 26 November meeting at the latest. The longer it takes to present an official agreement, the higher the probability that the Spanish curve could get hit in contagion selling.


Finally, US. President Obama has begun discussions with Congress to extend tax cuts for the middle class and find USD1.6trn in new revenues. We do not expect many developments next week as it will be short owing to the Thanksgiving holiday.

Finally, and as usual, the remainder of the recap, comes from Jim Reid's crack team of recappers:

You know that you're in the home stretch for the year when Thanksgiving week is upon you. The US will be on holidays this Thursday and will have a half day of trading on Friday. So expect all the predictions and newsflow about retail activity as we approach and hit 'Black Friday'. Christmas slowly builds from there, although in an hour’s drive over the weekend, the radio played three Christmas songs so perhaps it’s too late to avoid already!! Even with the US winding down as the week progresses there is lots to focus on. The main highlights of the week are Tuesday’s Eurogroup/ECOFIN meeting which will focus on the latest Greece disbursements and fresh attempts to address debt sustainability, the latest and very important Global flash PMIs on Thursday and a two-day EU leaders summit starts on Thursday to try to agree on the EU budget for next seven years. Expect a lot of grand political posturing as this summit progresses. There's an understandable reluctance for some countries to risk sanctioning an increase when austerity is biting domestically. As for the fiscal cliff it might not be an active few days as Obama is in SE Asia over the early part of the week and will be enjoying his turkey in the second half.

So with a potentially quiet week ahead for the fiscal cliff, markets might take some encouragement from Friday's news. Risk markets turned on Friday after House speaker John Boehner described talks with Obama and other congressional leaders as “constructive”. The S&P500, which was down 0.75% in the morning session before Boehner’s comments hit newswires, rallied more than 1.2% from the lows to close 0.48% higher on the day. Gains were broadbased with nine out of 10 industry sectors finishing higher on the day. Boehner’s comments helped US treasury yields sell off 3bp to close virtually unchanged at 1.580% and the VIX to drop 2pts to close 8.8% lower on Friday. Boehner continued the conciliatory tone on Twitter, describing his “two-step framework” for reducing the deficit that includes tax reforms and spending cuts as “consistent with the President’s call for a balanced approach” and that he was “confident both parties can come together around a deal to avert the fiscal cliff”. On his part, Obama said at a press conference in Bangkok on Sunday that he was “confident that we can get our fiscal situation dealt with”. Treasury Secretary Geithner said that he’s confident an agreement on averting the fiscal cliff can be concluded within weeks.

The conciliatory tone from Washington has flowed through to Asian markets overnight. Risk appetite is also being helped by reports that an Egyptian-brokered Israel-Hamas ceasefire is being explored. Asian equities are generally trading higher, paced by the KOSPI (+1.1%), ASX200 (+0.57%) and Hang Seng (+0.41%). The Nikkei (+1.45%) is outperforming for the third session in a row following opposition leader Shinzo Abe’s dovish comments over the weekend. Abe he said would consider making the BoJ purchase construction bonds directly from the government to tame deflation, further blurring the wall between the State and the BoJ. He would also appoint a central bank governor that would agree with his proposed inflation target of 3%. The Yomiuri newspaper published a poll on Friday showing Abe’s party leading with 26% of voter preferences, compared with the incumbent DPJ’s 13%. However with as much as half of voters undecided, there's a fair amount still to play for ahead of election day in mid-December. So American and Japanese politicians will keep us busy well after Thanksgiving!

Elsewhere Chinese equities are underperforming, with the Shanghai Composite (-0.6%) again testing the 2000 level. DB’s Jun Ma is optimistic on reforms under the new leadership, with economic reforms in many areas able to move faster than expected. He believes that the most likely economic reforms in the coming three years include resource pricing reform, interest rate liberalization, greater exchange rate flexibility and capital account liberalization, nationwide implementation of the VAT reform to more service sectors, a new resource and environment tax system, and an increase in social spending. Here's a link to report if you're interested. In other markets, the Asian IG credit index is 5bp tighter, the AUD trading 0.4% higher against the US dollar while spot gold (+0.5%) is up at $1722.6/oz.

Turning to the Israel-Hamas conflict, there are a number of conflicting reports on the progress of Gaza ceasefire talks. UN Secretary General Ban Ki-moon is due to arrive in Cairo to help with truce efforts. Israeli media said a delegation from Israel had met with Egyptian officials in Cairo for talks on a ceasefire (Reuters), although this has not been confirmed by the government. Meanwhile, reports continue to suggest that Israel is massing forces at the Gaza border for a potential “significant widening” of operations and that the Israeli military have begun calling up 75,000 reservists. Brent crude futures are +0.7% as we type ($109.7/bbl) during the Asian trading session.

On Greece, ECB executive board member Joerg Asmussen said that European leaders should agree on aid to Greece for 2013 and 2014 this week. Italian Finance Minister Grilli was also confident of reaching a deal, although IMF's Lagarde appeared less certain and noted that an agreement among Greece's creditors on how to reduce its large debt pile should be "rooted in reality and not in wishful thinking". The EU Summit on Thursday may prove controversial with the FT reporting that EU officials are studying a plan to create a longterm budget without the UK's involvement reflecting frustration at PM Cameron's demand for spending freezes.

Taking a look at the calendar for rest of the week, US dataflow will be mostly front-ended loaded due to the shortened week. We have existing home sales today followed by housing starts/permits on Tuesday and the Markit US Preliminary PMI on Wednesday. Chairman Bernanke is scheduled to speak at the Economic Club of New York on Tuesday and it will be interesting to get his latest thoughts on ‘fiscal cliff’ and any hints of QE4 as hinted by the last week’s FOMC minutes. The US treasury will auction a total of $112bn of 2/5/7 year notes throughout the week and a 10yr TIPs on Wednesday. In the Eurozone, the above mentioned flash PMIs on Thursday will be the key focus. The Eurozone consumer confidence numbers are also due on the same day followed by German final Q3 GDP, trade balance and the IFO survey on Friday. On the political front, we have elections in the Spanish region of Catalonia on Sunday (25th). Ahead of this key election, Spanish PM Rajoy said that Catalonia mustn’t risk leaving the EU by pushing for independence from Spain adding that Catalonia benefits from Europe as the rest of Spain does. In Asia, the BoJ meeting on Tuesday and China's HSBC flash manufacturing PMI on Thursday are the main highlights. On the former, the consensus is expecting the BoJ to hold off on additional easing until after the elections.