By Marc ChandlerNEW YORK ( BBH FX Strategy) -- Markets rallied strongly in response to the European developments. Yet it is an exaggeration to think that risk appetites returned as the whole month of October has seen equities, emerging markets, commodities and foreign currencies trend higher, recovering from their neck-breaking, wealth-destroying plunge in September. Still, the advance on Thursday was impressive, helping propel the euro and the S&P 500 through the 200-day moving average, allowing sterling to test its similar moving average and pushed the dollar to yet another marginal new record low against the Japanese yen. We think the market is getting ahead of itself, but the technical momentum and positioning may allow for an extension of the move. Medium-term investors may need to be patient, but the fundamentals will likely reassert themselves shortly.
There is approximately another 20% of Greece's debt that is not covered by the scheme; that means that the burden falls to the other 60%. One of the larger holders with about 20% of Greek debt is pensions. Greek pensions, which are thought too largely invested in governments bonds, are going to be halved or nearly so. The Greek government, the only aid-receiving eurozone country that has not collapsed, is weak and vulnerable. Halving pensions may topple the government, especially if the finance minister and opposition leaders seek a super-majority (180 votes in the 300-seat chamber, while the government has barely secured a simply majority in recent months).
While undermining the legitimate function of the CDS market, there might be something to learn from the gaming of the haircut/default distinction. A voluntary haircut is nothing more than debt forgiveness. Banks, insurance companies, pension funds lent money to the Greek government. Recognizing Greece cannot pay it all back, they have said they will forgive half of the debt. While entirely self-serving, as mark-to-market would require even deeper losses, and there is the implicit and explicit threat of a hard restructuring, the forgiveness is noble.
It is not clear what will be the catalyst for the fundamental skepticism of Europe's latest efforts to re-emerge as the key driver. It may be a reminder that the real challenge for Europe is to sustain growth in the face of austerity (like the real challenge in the U.S. is sustain demand despite poor wealth and income growth and de-leveraging). This may come in the form of the Institute for Supply Management reports that point to an economic contraction in the eurozone. It may come from countries revising down 2012 growth forecasts that require greater austerity to meet budget targets. France will soon officially recognize that growth next year, for example, will not be 1.7% next year but closer to 1%. This will require another 6 billion to 8 billion euros in budget-saving measures. It may come in the form of a political shock, with Italy and Greece being the more likely candidates.