Do Europe’s woes have any relevance for Australia? Should you be worried about Greece and its demands for debt relief or the risk of an exit from the euro? In short, yes. Everything in the financial world is connected…more so than ever before.
It’s a topic I’ll explore in today’s Daily Reckoning. But first, a quick look at the overnight action…because there’s plenty to talk about.
Where to start? Well, to kick things off, something very unusual happened in the US trading session. The Federal Reserve issued a statement on monetary policy and the market went down. That’s not how things normally work. The fed speaks, the market goes up…
Making things more bizarre was that the market apparently interpreted the statement as being dovish on interest rates. This suggests that the Fed is reluctant to raise rates too early. But if you read the actual text, you’d be none the wiser on what the Fed has planned. Here’s the important bit:
‘Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.’
Go that? The ‘committee’ (*shudder*) is going to be patient, and it may increase rates faster or slower than the market currently thinks.
Well, thanks for the heads up, Fed. Clear as mud.
But hey…at least they’re being honest, even if they have to tell us they don’t know what’s going on in a convoluted way. It’s the media who’s to blame…they lap this central banker stuff up like some beaten down, subservient dog.
But I’m getting off the point, which was the market went down despite the Fed statement. Perhaps the punters didn’t like the indecisive tone from the Fed. Or perhaps they’re just starting to reprice risk appropriately again.
More than likely this is just part of a correction/consolidation period for US markets. US stocks have risen relentlessly over the past five years. Decent corrections have been few and far between. Now, with the US liquidity tap turned off (for the time being) a decent correction shouldn’t come as too much of a surprise.
Commodity prices also fell overnight, with oil making a fresh low for the move and gold backing off a little after its recent strong run.
In Europe, the major indices performed well but Greek bank stocks collapsed. From the Financial Times:
‘The country’s four biggest lenders saw their stock prices plummet by an average of more than 25 per cent just two days after Alexis Tsipras, leader of leftwing party Syriza, was sworn in as prime minister. It was the third day of double-digit share slides for the banks.
‘A sell-off in Greek debt also accelerated on Wednesday, sending short-term borrowing costs to their highest level since Greece’s 2012 debt restructuring.
‘In the space of a few hours, the yield on three-year Greek bonds jumped 2 percentage points to almost 17 per cent, as investors wondered whether Greece would honour its debts in the near term.’
If you want to know what’s really going on in Greece, it pays to listen to the bond market, not what politicians or bureaucrats are saying. Right now, the bond market is flashing red, saying that under the current structure, Greece is a basket case and an unquantifiable risk.
That’s because it’s still labouring under €320 billion of debt, debt that the Germans expect to be repaid. From the same FT article:
‘German economy minister Sigmar Gabriel on Wednesday warned Greece not to expect taxpayers in Germany and other eurozone countries to pick up the tab for its policy decisions.
‘The social democrat leader’s firm line echoes positions taken by his conservative coalition partners, led by Chancellor Angela Merkel, and suggests that Berlin is united behind a tough approach towards the new government.
‘Mr Gabriel said the aim was to keep Greece in the eurozone, but this would require Athens to adhere to the terms of the bailout.
‘“If Greece wants to deviate from some of these measures, it must bear the cost itself rather than exporting this to other European countries via a debt cut or other such ideas,” Mr Gabriel said.
‘“It is clear that we must aim to keep Greece in the eurozone. But it is also clear that we need to be fair to our own population and other euro states,” he added, pointing out that foreign taxpayers were contributing €278bn to support Greece.’
I pointed out the absurdity of this argument on Tuesday and I’ll do it again. Greece didn’t ‘get’ the bail-out funds. It’s a low interest loan with strong strings attached. The money went to Greece’s creditors (banks) who took big risks knowing that they would get a bailout if things went wrong.
And they were right. The ECB and IMF bailed out Greece’s lenders and dumped the tab on the Eurozone’s taxpayers. And now they want their pound of flesh from the Greek population.
Greece should just tell them to shove it, default on their debts and return to the drachma. It will be tough at first, but if they can run a balanced budget and improve trade competitiveness via a lower exchange rate, within a few months, capital markets would begin lending to them again. Interest rates will be much higher than in the Eurozone but the debt burden will be much lower. Within a year or so, the economy will start to flourish.
That’s a much better option than staying in debt servitude for decades, all because a bunch of bureaucratic central planners bailed out failed banker loans.
Do yourself a favour Greece…Europe needs you more than you need them.
So what effect will all this have on Australia, if any?
Europe is a major source of capital for Australia’s banks. The Eurozone as a whole runs a sizable trade surplus, meaning it has excess capital to export. The last time the euro was in crisis was 2010–12.
The increase in risk that characterised that period came with increased borrowing costs for Aussie banks on their euro-sourced loans.
Therefore, any future turmoil in the Eurozone could translate into higher borrowing costs for the banks, which could limit the flow of credit to Australia’s housing market.
This would be a good thing, but for an economy standing on a gammy peg-leg of ever rising house prices to create an illusion of wealth, it probably won’t go down too well.
In reality, no one knows how a Greece default or exit would play out. But you can be sure the financial effects would ripple out across the world in some way. As I’ve been saying, the world’s financial system is breaking apart under the heavy burden of cheap money. Expect this trend to continue, and increase pace, in 2015.
for The Daily Reckoning