When will market uncertainty be a thing of the past?  Investors keep asking this simple question, almost rhetorically, but no easy answer has been forthcoming as tension continues to mount in our financial markets.  The European debt crisis is in its third year of evolution with a glimmer of light at the end of the tunnel, but keep your matches at the ready.  Previous “flickers” of hope have been extinguished by the slightest of contrary breezes, and government officials profess that the current issues will require years to reach a favorable resolution.

The current “crossroad” is teaming with political risk.  European banks, nearly 800 strong, received a liquidity cushion when the European central bank pumped over 530 billion euros onto their respective balance sheets.  Expanding the money supply is expected to prepare banks for an orderly Greek default while stimulating growth in domestic economies.  It is uncertain as to how the banks will deploy these new funds, but if the U.S. market is any indication, banks will be slow to turn on the lending engine.  Stock buy-backs, acquisitions, and exporting funds to opportunities overseas are more likely to happen.

At this writing, the Greek “deal” still has a few hurdles to clear before bailout funds can be released.  The current “hurdle” requires existing bondholders to agree to a sizable “haircut” on their holdings, forfeiting up to 75% of their present value.  The alternative is a hard default on March 20 when payments are due.  Greek officials are hopeful of a 90% consensus, but, if the actual result is less, then they plan to exercise “Collective Action Clauses” (CACs) to force an agreement, a process already deemed to be legally messy.  A high capitulation rate must occur in order to meet the savings target contained in their bailout deal for 130 billion euros.  These funds will allow the Greek government to operate going forward.

The only real solution for the crisis is economic growth in the region.  Recent data suggests that the Eurozone is slipping once again into recession.  Germany and France may skirt by, but weaker member states are having problems.  Greece is actually in their fifth year of recession.  Future GDP targets may not be conservative enough, requiring more bail out funds in the future. Portugal and Ireland are both problematic, and Spain has announced that it cannot meet the targets set for its economy.  Italy bond premiums are increasing, another indication that the market is not pleased.  Contagion is a reality, and more bailout deals will have to be engineered in the near-term.

Rumors are also running rampant, especially in Germany where officials would prefer that Greece disappear.  Referred to as “Plan B”, the expectation is that Greece would declare bankruptcy on March 23^rd, announce a banking holiday, and then agree to withdraw from the Eurozone, based on another “backroom” deal constructed in the shadows.  Many analysts believe the potential for this scenario is currently keeping the Euro at high levels, far above where the investment community believes the Euro will fall as the regional fiscal situation continues to deteriorate.

In the meantime, China is ratcheting their growth expectations downward, a response to weak demand from Europe and the West.  Bernanke and the Fed are dusting off more quantitative easing measures in case of a “hiccup” in Europe, while economists focus their attention on job growth and unemployment.  Last year’s recovery stalled when the European crisis worsened.  Is it “déjà vu” all over again?

Uncertainty will not dissipate any time soon.  Caution is the watchword for all investors.

Article by Tom Cleveland from ForexTraders.com

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