Markets Remain Tentative Amid Greek Uncertainty

28-Sep (USAGOLD) — Gold is higher this morning, but still in the lower-third of this month’s range, as ongoing uncertainty about the fate of Greece continues to have global markets on edge. The troika returns to Greece today to resume their audit. You may recall that the troika abruptly departed Athens early in the month over disagreements with the Greek government about their massive budget deficits and how best to make up for the funding shortfalls.

If they were disenchanted then, certainly they are going to be less than thrilled now. Due to the slow implementation of austerity measures and economic downturn — which is being largely driven by those very same austerity measures — Greece’s funding needs have continued to grow. The €109 bln bailout2.0 that was agreed to just 2-months ago simply isn’t going to suffice any more. According to the FT, “Athens’ funding needs over the next three years have grown beyond the €172bn forecast this summer.”

German Chancellor Angela Merkel has already hinted today that the terms of the July bailout may have to be renegotiated, saying, “We have to wait and see what the troika … finds and what it will tell us (whether) we will have to renegotiate or not.” Well, if she really wants to prevent an disorderly Greek default and contagion to other EU member states, she better plan on coming up with some more money (or authorize more leverage). Merkel faces a critical vote in the German parliament tomorrow, where she is hoping that expansion of the EFSF will be authorized.

Fragmentation within her own party makes such authorization anything but a sure thing, but markets seem to be holding out hope that German policymakers recognize how dire the situation really is. If the Bundestag blocks expansion of the EFSF, all-hell would likely break loose. Since the German constitutional court made it clear that parliament would have the final say about German participation in future bailouts several weeks ago, vested parties have been scrambling to put contingency plans in place in case of a possible “nein” from the Bundestag. The plans primarily would result in a massive flood of liquidity into the European banking system, but whether that would actually prevent broader contagion to other already vulnerable PIIGS is dubious at best.

The massive deleveraging seen across global markets in recent sessions is reflective of the markets unease at the realization that Europe may well be running out of time. While further delevereging can not be ruled out, if Europe leads the world back into financial crisis, gold is a critical hedge against the systemic risks that will result.

While the recent rise in growth risks and resulting worries of possible deflation may have contributed to the sell-off in metals, German CPI unexpectedly accelerated to 2.6% y/y in September, its highest level in 3-years. Meanwhile, German HICP inflation rose to 2.8%. The ECB gave themselves a little maneuvering room with some controversial rate hikes earlier in the year, but these data out of Germany may have effectively hamstrung the central bank.

The defining moment in German economic history is the nightmare hyperinflation of the Weimar Republic. German’s are understandably extremely sensitive to price risks. As the ECB is for all intents and purposes an extension of the German Bundesbank, one can expect monetary policy to be generally reflective of the best interest of Germany…particularly when it comes to inflation.

If a rate cut is off the table, that leaves more unconventional measures as the only real options. While such measures may also prove inflationary, the ECB has been somewhat successful in end-running any potential German objections (and perhaps the intent of their mandate) by executing quantitative easing in the secondary market. The Bundesbank has expressed displeasure at these bond purchases in the past and has vehemently objected to both broader ECB bond buying authority, as well as eurobonds; the two measures that many economists agree have the best chance of staving-off periphery defaults.