The Greek debt crisis fanned a broad sell off Wednesday and it will no doubt keep markets on edge Thursday.
U.S. Treasurys, the dollar and precious metals were the winners Wednesday in a flight-to-safety trade. The euro took a beating and risk assets, like stocks and oil, got slammed on concerns Greece will be unable to avoid default. The euro skidded 1.8 percent against the dollar, to 1.4181, its lowest level since May 26.
"The euro's certainly in a decline phase until we get some real clarity on the Greek situation, and by clarity, I mean we need Greece to agree to the kind of austerity package that is on the table," said Alan Ruskin, global head of G-10 currency strategy at Deutsche Bank. "If everything is going to be up for renegotiation, the euro is going to be under a lot of pressure."
Disappointing data also hit the markets early Wednesday when the Empire State manufacturing survey showed a surprising contraction. Thursday's data includes the closely watched weekly jobless claims and housing starts, both at 8:30 a.m. The Philadelphia Fed survey is released at 10 a.m.
Barclays Capital's Barry Knapp said the underlying reason for the market's angst is that the U.S. economy looks to be stalling at a low growth rate. "I would say until the growth outlook is settled in the U.S., (stocks) we're going to struggle...At the end of the day. I think the big stabilizing force for the global markets is the U.S. economy. That's why we're reacting much more to this (Greece) than if the U.S. growth outlook was in tact. Crude probably wouldn't have gone down this much," he said.
Greek unions went on strike Wednesday to protest asset sales and austerity measures. Images of rock throwing protesters and smoke in the streetsserved as a backdrop for markets that became increasingly concerned about the ability of the EU, IMF and Greece to structure a new bailout plan in time to meet Greek debt payments this summer.
Unsettling also was word that Greek Prime Minister George Papandreou would form a new cabinetThursday and seek a vote of confidence from his Socialist party for the austerity bill. Papandreou also offered to step down and form a unity govenrment, but he dropped the idea after the conservative New Democracy party demanded renegotiation of the original year-old $110 billion euro bailout.
The EU has been trying to fashion a new bailout package for Greece, but members are at odds. Germans are pushing a plan to share the burden with private investors but there are concerns modifications could result in a credit default. Moody's is warning that France's biggest banks could be downgraded since they are exposed to Greek debt.
Besides the cabinet reshuffle in Athens Thursday, investors are focused on a meeting Friday between French President Nicolas Sarkozy and German Chancellor Angela Merkel in Berlin. The EU finance ministers meet June 20, and were originally expected to agree to a Greek package at that meeting, but now the new bailout may be delayed unitl July 11 due to differences, according to Reuters.
"The market came in thinking they're going to get a deal done because the cost of not getting a deal done was so horrendous. The market started to lose confidence in a policy solution. There were the riots in the streets, and the Papandreou statement that he was willing to resign. That was when the whole sentiment turned," said Boris Schlossberg of GFT Forex.
"Instead of compromise, we're now getting to the point of more conflict...I think the trade here is compromise and conflict, and right now the forces of conflict are winning," Schlossberg said.
Knapp, who heads Barclays equities portfolio strategy, does not believe the EU would risk a default and that an agreement will be reached. "I just don't think the European banking system is far enough along in the recapitalization process," he said.
Risk Hits the Fan
As the euro sank Wednesday, so did risk assets, particularly oil, which lost 4.6 percent to settle at $94.81 per barrel. Risk assets and the euro have been locked in a trade where they rise and fall together, moving counter to the dollar.
The Dow fell 1.5 percent to 11,897. The S&P was off 1.7 percent at 1265, its lowest close since March 16, when markets were reacting to fears of a nuclear disaster from the crippled reactor in Japan.
Financial stocks, down 2.2 percent, led the stock market decline and were joined by energy, down 2.2 percent and materials, off 2.3 percent.
Bank stocks played a central role as traders watched record wide spreads on Greek credit default swaps, which are a kind of insurance policy on the sovereign debt.
"On the other side of all these CDS trades are banks. If and when you ever get a default that's billions of dollars of exposure to these names," said one trader.
Kevin Ferry of Cronus Futures Management said, however, the net exposure to the Greek CDS is not that great, but he did say there are some signs fear is creeping back ino the markets. "If you look at the front of the eurodollar curve, there's stress there for the first time," he said. He also pointed to the race by investors to snap up long-dated Treasurys Wednesday. The yield on the 10-year was at 2.971 late in the day.
"It had a real panicky feel in the middle of the day," said Rick Klingman, managing director Treasury trading at BNP Paribas. "It was a pretty quick move."
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