Greek default risks loom, but why this is not euro negative remains a mystery

Outlook:

Yesterday Fed chairwoman Yellen said “I believe that the appropriate time has not yet arrived, but I expect that conditions may warrant an increase in the federal funds rate target sometime this year.” This is a belief and not a fact or a forecast, but it’s a good bet that Yellen does not want to delay into 2016.

Another key point: the fixed income market didn’t blink. The 10-year yield wobbled a little but within a range of 3 points. We know the Fed fears another taper tantrum and is obsessed by the machinery of the transition to normalization, but perhaps the yield experience so far is a palliative. We are not going to freak out this time. Heaven knows, it’s been coming long enough—market participants should be pre-pared.

Now that any old factor can impress traders, we have to worry about the slew of material coming our way today and tomorrow. We get the usual weekly jobless claims plus the Philly Fed, the most im-portant of the regional Fed surveys. We also get the Chicago Fed activity index and leading indicators, plus existing home sales, expected higher if not at the sizzling pace of new homes. And CPI tomorrow is not expected to show anything interesting or surprising, but everyone is open to such an event. The ques-tion is whether faith can be restored that Q1 was an aberration and the rest of the year will be rosy, or at least rosy enough to satisfy the Fed in September.

Or, if data is disappointing, as is most likely, the pullback will proceed. We could easily see 1.1500. But remember, this is largely position adjustment and not a final resolution. At some point good US data will remind everyone that policy divergence is real and important. That is, unless US data is bad.

And looming over everything is the likely prospect of Greek default. Default on the IMF will lead to default against other institutions because of cross-default clauses. Evidently Greece is scrambling to offer VAT and other reform ideas while hanging on to labor and pension red lines, and it’s very un-likely the proposals will fly. One report has it that German Chancellor Merkel is stepping into the leadership role, to keep the squabbling boys Varoufakis and Schaeuble apart, but we don’t buy the idea that she feels desperate to hold her legacy by engineering a deal with Greece. Politically, she is smarter than that. In any case, no one expects a deal out of Riga and June 6 inches closer. Why this is not euro-negative remains a mystery.

Remember that tomorrow will be a short day in the US, even if markets stay open to the bitter end (bonds close at 2 pm). Monday is the Memorial Day holiday in the US—no reports—and as reported earlier, we have jury duty on Thursday, May 28. The holiday will presumably trigger some position par-ing and we look for markets to be thin by noon Friday and on Monday. As of 8:30 am on Thursday, the euro recovery is looking soft. We will need to see 1.1210-1.1260 for the scenario to play out. We could also get a test of 1.1060 again, in which case the Fed-inspired move was just a burp. This is what “should” happen on the fundamentals, but we can never count on fundamentals.