Greece Headed for Involuntary Default

Signs that Greece is pushing bondholders for a harsher haircut point to the likelihood that credit default swaps will eventually be triggered. The euro continued falling on Friday while USD was the top performer. We take a look at the weekly charts, as well links to our Premium USDX & EURUSD charts.

Some positive sentiment crept into a holiday-curbed US trading session on a report that European leaders are likely to abandon plans to have the private sector participate in the permanent bailout fund. The same report, which cited anonymous sources, also said Germany was softening on Eurobonds. The news sent the euro to nearly 1.33 from a seven-week low of 1.3212.

The sentiment was washed away by: 1) Finland continuing to rail against Eurobonds 2) S&P downgrading Belgium to AA from AA+ 3) the ECBs Mersch saying ECB not ready to take action on bank liquidity problems and 4) a report saying Greece is looking for a better haircut.

Point 4 threatens to undermine EUR for the remainder of the year. The agreement on a 50% haircut appears to have remained in place but the coupon and duration of the new debt is a major stumbling block.

Its also increasingly likely that the bondholders who do not like the terms of the deal will be forced to accept them anyway because the bonds are written under Greek law. This will trigger the roughly $5 billion in credit default swaps. It is a relatively small sum but a $5 billion ripple through the crippled European financial system could spark a liquidity crisis.

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The S&P 500 fell 0.2% to 1159, ending the week 4.7% lower. Weekly CFTC positioning data was delayed until Monday due to the US holiday.

Weekly Charts

It was the fourth consecutive week of losses for EUR/USD and the lowest weekly close since Jan 2. The Oct low of 1.3144 will be a major focus of the week ahead. We said last week that the path lower is clear but short-squeezes are a threat and that remains the trade. A bounce to 1.34 will be hit by aggressive selling.

Other weekly charts are mirroring EUR/USD as market correlations tighten, a classic sign of risk aversion. An interesting exception is USD/CHF, which edged to an eight-month high of Friday. We made a bullish warning about this pair a month ago and a daily close above 0.9315 will clear the way for further gains.