The holiday shortened market week did not mean a shortage of drama, with global equities featuring big up and down days before finishing the week in negative territory (S&P 500 down 1.2%). Stocks were down big on Friday based on worries that Greece will default over the weekend. Accordingly, treasuries rallied, pushing the note on the 10 year to a record low of 1.93% during Friday’s session. Obama’s speech promoting a $447 billion jobs plan was not viewed as a major event. The Euro was down about 5% vs. the dollar.
Tuesday – The Swiss national bank unexpectedly set a limit on the Franc/Euro exchange rate, sending the Franc down 8% and catching many traders off-guard.
Wednesday – Global stocks rally as a German court ruling cleared the way for a Eurozone bailout plan for Greece.
Thursday – President Obama outlined a $447 billion jobs plan, which was centered on keeping employment taxes at current low rates.
Friday – Stocks tumbled on rumor that Greece may default on debt as soon as this weekend.
We expect Greece will be forced to default, but know of no good way to determine the timing. Actually, assuming it is a relatively orderly event (which it should be given it is not a sudden development), we believe Greek default is likely to be a positive catalyst for the markets. The main concern is the unknown consequences and a potential chain reaction which leads to an unraveling of the Euro. We expect some countries will withdraw from the Euro in the coming years, but see no reason to expect a collapse of the Euro itself. The Euro is still overvalued relative to the dollar on a purchasing power parity basis, and some devaluation would be healthy for all.
President Obamas speech was largely a non-event. His extension of cuts on employment taxes seems reasonable but won’t have much impact. One reason the markets may have reacted negatively is the final realization that the government simply doesn’t have much ammo left to stimulate the economy. Bernanke on Thursday reiterated his claim that the Fed has more tools available and is ready to use them. This is mostly a bluff at this point. As Pimco’s Bill Gross pointed out this week, forcing yields down further at the long end of the curve (longer maturity Treasuries) would probably do more harm than good as it will flatten the yield curve and reduce desire for banks to borrow and lend.