Greece might get a third bailout for a higher amount and longer terms

Outlook:

Starting today, we will get a blizzard dropping the most snow in 100 years in New England, up to two feet. If you do not get reports, it’s because we lost electrical power. We take comfort in knowing that it’s 53 days to spring. The blizzard will hit New York, too, and thin out the FX market.

We have two themes this week, the Greek negotiations and the Fed. About the Greek election: so far the market response is fairly tame. The Bloomberg headline says “Greece sets collision course” but bare-knuckle fighting in not in the cards, according to other sources. The win by an anti-austerity party will supposedly give anti-austerity parties in other countries (like Italy) a leg up, but nobody in his right mind would seek a Greek solution—default, etc.

The Athens stock market dropped over 5% but came back to down only about 1% around noon Athens time. The 10-year yield recovered to 8.37% from 8.89%, not nearly as bad as 10.3% on Jan 7. We should not have been surprised that Syriza won so much of the vote--36.3% for 149 seats, only two short of a majority. And Tsipras was already in talks with the Independent Greeks, whose leader Kammenos shares the Syriza stance that austerity has to stop and debt needs to be cut. Kammenos is the one whose withdrawal of support for the government triggered the election in the first place.

According to the FT, Germany opposes any change in the amount or terms of the Greek bailout, so it looks like a head-on clash. Finance ministers are meeting today to talk about it. “Mr Tsipras’s options appear limited because Greece’s funding needs in 2015-16 amount to roughly €28bn, of which €4.3bn fall due in March and another €6.5bn in July and August. Greek banks rely on the European Central Bank for favourable funding arrangements, which the ECB has warned it will halt without a new agree-ment between Athens and its creditors. Meanwhile, Greece will not benefit from the ECB’s government bond purchase initiative, announced last week, until at least July because the central bank already owns a stock of Greek debt close to its self-imposed limit.”

We have been guessing that Greece will get a new (third) bailout for a higher amount and longer terms, plus maybe a little wiggle room on budget austerity. In a crisis of this magnitude, short repayment terms were never appropriate. Germany opposes a third bailout so extending terms is the obvious solution, alt-hough it’s a little funny that a German Finance Ministry spokeswoman said “… it depends on how such a request is formulated and on the overall context, but in principle that [extending terms] is an option." In other words, the Greeks can’t yell and have to be respectful as they hold out the begging bowl.

Another write-off is not going to happen, says Eurogroup chairman Dijsselbloem. Germany may have to hold its nose and sign on to better terms, but before then, the situation is vulnerable to turmoil if rash and incendiary comments get made. The euro is not out of the woods, even if Grexit is not really on the table this time. One of the key aspects of the new negotiation should be a more realistic set of economic pro-jections. As Krugman points out in the NYT, the troika used really bad assumptions on recovery arising magically from budget cuts within a few years. Two things: austerity worsened the recession--it’s not budget cuts that inspire renewed or robust activity. And the timeframe for expecting recovery from any impetus was far too short.

Big-name investors are not scared of a crisis or contagion. A BlackRock manager told Bloomberg “If you are a broad European investor you should be relatively relaxed. If you look at the long end in Italy, the long end in Spain, they are actually up in price, down in yield. If the market were super concerned about spillover, we wouldn’t have those reactions.”

Bloomberg goes on to note that the Italian long bond (30 years) shed 10 bp 2.58% this morning and was as low as 2.518%, the lowest since Bloomberg began compiling the data in 1994. Italy’s 10-year yield fell 1 bp to 1.51%--yes, below the US equivalent. Last week it was as low as 1.413%. Meanwhile, “Spanish 30-year yields slid six basis points to 2.36 percent and touched 2.291 percent, the lowest on record.” The absence of contagion is important. With two-year yields negative in the majors—Germany, Switzerland—the euro doesn’t look so bad but the dollar looks better. On Thursday we get the EMU flash inflation number, expected at -0.5% from -0.2% on falling energy costs, albeit with core at the same 0.7%. If inflation is not worse, and if the idea catches hold that the drop in official inflation num-bers is starting to stabilize, the euro could look less bad.

As for the Fed, we should assume that the brainy guys behind the scenes have a ton of data, including the estimate of Q4 GDP, that the rest of us don’t have. At a guess, the Fed will not be willing to say any-thing new or different. Some members will be attending for the last time as the usual membership rota-tion proceeds. We will still be in the dark about whether June is the date to expect a hike. Analysts seem to be about evenly divided. We are coming down on the side of yes, June, if only because the Fed wants to project an air of knowing what it’s doing. But markets have not yet built in June, so some volatility is to be expected and of course we never know how those flighty equity guys will behave.

On the whole, we expect a bounce in the euro as the perspective takes hold that nothing too terrible has happened yet in Greece and investors are unwilling to buy into contagion. Draghi is a hero for proposing bigger and bolder QE, and unless the creek rises, the US is on course for a return to normal in the spring. So, the euro doesn’t look so bad but the dollar still looks better—it may take a few days for the big pic-ture to reassert itself.