Greek rally to be shortlived

What a ride on markets last week. Initially, investors gave the thumbs-up to the €100 billion Spanish bank bailout. But euphoria quickly shifted to concern that the bailout was insufficient and would only add to Spain’s already mountainous debt obligations. Spanish 10-year yields hit all time highs this week as credit agencies again downgraded both Spain and its major banks.

The economic data has continued to cool just about everywhere. This week, May’s disappointing U.S. retail sales and the worrying trend of higher weekly jobless claims added to evidence of a slower U.S. economy. Elsewhere, Chinese and Eurozone industrial production were both light of expectations revealing weakness there as well.

The weaker growth data has combined with cooling inflation figures, which provide investors with a silver lining. The market has increasingly priced in a Fed move for either QE3 or at the very least an extension of Operation Twist at this week’s FOMC meeting.

Investors also took kindly to a report from a G20 official (the G20 was in Mexico this weekend) that suggested a liquidity plan is in place, ready to respond to disorderly financial markets on an unfavorable Greek outcome.

Brent crude prices initially surged on China’s trade data but then prices settled into a US$97-$98/bbl range for most of the week. WTI crude prices are basing just above the $80/bbl level. Gold bullion rose steadily last week, effectively pricing in a weaker U.S. dollar and the possibility of imminent central bank money printing. The Canadian dollar was volatile but did finish the week slightly higher against the greenback ahead of the Greek vote.

TRADING WEEK AHEAD

To simplify what is shaping up as possibly a watershed week for investors, the focus needs to be on two key events. The outcome of the Greek election and the subsequent FOMC meeting will set the tone for trading this week. Thanks to a New Democracy victory, investors can expect a short relief rally for risky assets. We think it will be short-lived only because a new government fixes none of Greece’s burgeoning problems of high unemployment and no growth remain unresolved.

The May 6^th vote allowed Greeks to voice their rage and fury towards the Eurozone-imposed austerity measures. This time, a new theme emerged based on fear. Anger at the austerity being demanded in return for financial help has given way to fear of the unknown and fear of the future.

Although official opinion polls were banned ahead of the vote, the politics of fear gave the “pro-European” conservative bloc the upper hand. We expect the new government will work to water down some of the austerity measures.

In the case of the Federal Reserve, this week is an opportunity for the Fed to show it’s receptive to further easing. While we may not necessarily hear about the immediate launch of another QE program, the FOMC policy statement could contain language that suggests QE3 is on the horizon.

On Wednesday, we will likely get an extension of the Fed’s Operation Twist until another program, likely involving mortgage-backed securities, can be formalized.

On the data docket, U.S. housing starts (Tuesday) should show signs of only modest improvement in the housing market. Thursday’s U.S. existing home sales are expected to show a small decline. Pending sales lead existing sales by a month or two and pending sales declined in May. Despite the expected decline on the month, the trend is still on the mend.

Our May estimate is more than 6% above the 2011 average.