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Daily Commentary 23/02/15

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• When the irresistible force of Democracy met the immovable object of Bureaucracy, guess who won? Greece Friday capitulated as more and more money left the Greek banking system (estimated EUR 800mn a day) and it became clear that capital controls would be necessary soon if an agreement wasn’t reached. Moreover, the Greek government would have run out of money in any event. Greece basically had to accept virtually all the demands of its creditors: asking for an extension of the hated reform program, complete with monitoring by the troika, and promising not to roll back reforms introduced by previous governments or to introduce any new measures that will widen the deficit. In return, Greece’s creditors agreed to extend its current bailout agreement for four months. I could see only two concrete concessions: 1) the troika was renamed “the three institutions,” and 2) Greece will be able to propose its own list of reforms instead of having them imposed from outside. But of course those reforms have to be acceptable to the creditors, so there is not that much leeway.

• Greece will submit to the Eurogroup by this evening a lists of proposed reforms, such pledges on structural issues such as tax evasion, corruption and public administration. If satisfied, they will endorse the list, which then goes to the various parliaments in the Eurozone for ratification. The Greek Parliament also has to approve the agreement, and some SYRIZA members could vote against it.

• Despite all the drama accompanying the negotiations, the agreement is only a temporary measure that simply allows for a breathing space while negotiations continue. First off, the agreement leaves several important issues unresolved, such as what reform measures Greece must adopt in order to get various aid payments. Secondly, the money will go to paying the interest on Greece’s debt, not to helping the Greek economy, so in fact the troika is agreeing to bail out European banks, not Greece. Most importantly, the financing lasts for only four months, meaning it ends right before Greece must make two crucial bond payments to the ECB totaling EUR 6.7bn. Greece does not have the money to make these payments, therefore discussions are likely to begin “very soon” on a possible third bailout for the country.

• During the four months, the two sides will negotiate the target for Greece’s fiscal position. Under the previous agreement, Greece was supposed to run a primary budget surplus – surplus before interest payments – of 3% this year and 4.5% in 2016. The EU wants Greece to run such a big surplus so that the country’s debt can fall from 175% of GDP currently to 110% by 2022. To call this “wishful thinking” is an overstatement, because that would imply it involves thinking as well as wishing, when in fact it is just wishing. One study of 54 countries from 1974 to 2013 found that only about 15% of the time did countries manage to run a primary surplus of at least 3% of GDP for five years, and surpluses of 4% of GDP for more than a decade were extremely rare (only five countries). The Greeks want a write-down of their debt so that they can manage to meet their debt/GDP targets with a more reasonable 1.5% primary surplus. One major concession: Eurogroup President Jeroen Dijsselbloem said that Athens may be able to lower the budget surplus target, which is a key demand of the new government.

• Nonetheless, the negotiation over this point is likely to be difficult as it will encompass a wide-ranging discussion about debt sustainability and the potential growth rate of the Greek economy. We can expect a last-minute crunch similar to what we saw this time around. The difference is that this time, the government was elected and immediately thrown into negotiations with a two-week deadline. It didn’t have any time to prepare. The next time, Athens will have four months to figure out a “Plan B” in case the Eurozone doesn’t go along with its proposals. Having a well-thought-out alternative, which could include leaving the Eurozone, could boost Greece’s bargaining position substantially. It could also make a Grexit more likely as there will be more time on both sides to prepare for that possibility.

• FX market impact: EURUSD bounced back from the lows on Friday after the news, but failed even to touch the 1.1450 highs of Tuesday or Thursday, and is opening in Europe at around 1.1377 – virtually unchanged from its 1.1363 opening on Friday. The market’s verdict therefore appears to be that while the talks were successful (hence no further declines in EUR/USD), they were not so successful as to improve the prospects for EUR. The underlying tensions within the euro remain, plus the pressure of the QE program that will start next month. I remain bearish on the euro.

• Today’s highlights: Aside from Greece, the main point of interest today is the German IFO survey for February. All three indices are expected to have risen. Following the strong ZEW survey released last Tuesday, this would add to the growing confidence that Europe’s largest economy is reviving. It could strengthen EUR a bit, but of course the currency depends more on what happens to Greece.

• The Swiss National Bank releases its weekly sight deposit data, which could show if the Bank intervened in the FX market in the week ended Feb. 20. Deposits were unchanged in the previous week, suggesting that there was little if any intervention.

• In the US, existing home sales for January are forecast decrease a bit. The housing starts and building permits released last week were consistent with an improving housing market. If the existing home sales are in line with a strong housing sector, this may be USD-supportive. Dallas Fed manufacturing index is also coming out.

• As for the rest of the week, the highlight will be Fed Chair Janet Yellen’s twice-a-year report on monetary policy to Congress (the Senate on Tuesday and the House of Representatives on Wednesday). Also on Tuesday, Bank of England Governor Mark Carney and other MPC members testify to the House of Commons Treasury Committee. On Wednesday, ECB President Mario Draghi testifies to the European Parliament in Brussels. Finally on Friday, we have the usual end-of-month data dump from Japan, including the important CPI figures.

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