29 June 2015

Market movements

There have been many key weeks for Europe in the past few years, but arguably none more so than this one. Never before has a member of the eurozone been so close to default – and so close to the potential to leave the euro itself. For most of the past month, the negotiations with Greece have resembled the cat in the Schrödinger experiment where, when locked inside a closed box with poison, after a time the cat can be either alive or dead; only when you open the box do you know. This time last week, movement from the box looked positive; in fact, there was the sense that a deal was pretty much done, which helped European equities rally 4–5% on Monday and Tuesday. However, Greek Prime Minister Tsipras opened the box late on Friday by calling a shock referendum on the Troika’s proposal, a dramatic last turn that showed the cat to be on its way out. Recrimination back and forth between the two sides continued into the weekend. European Union (EU) members implied that the referendum call torpedoed any chance of a deal before the 30 June deadline, when the current bailout package ends and the International Monetary Fund needs to receive its rolled-up payments from June. Meanwhile, the Greek government has blamed the Troika for putting in place a deal that embarrasses Greece. On Saturday night, the Greek parliament voted in favour of the referendum going ahead next Sunday, on 5 July. The problem with the referendum is that the question itself is not all that clear. In fact, it is based on a blueprint of a deal laid out by the Troika on 25 June, and not an actual formal proposal. The question is, how much in Greece is this seen as a vote on leaving the euro? One could argue that implicitly it is, as no deal makes it very hard to see Greece continuing within the currency bloc. Notably, an opinion poll by Kappa Research showed on Saturday that two-thirds of those polled want to stay in the eurozone, and 57.5% say Greece should back down and accept the deal. The ambiguity of the question makes prior opinion polls hard to use, so focus will be on new opinion polls in the coming days in the hopes of getting a better picture. Given the Greek government will be calling for a no vote, it will be tight. What happens after a yes or no vote is also unclear. Would a yes vote force new elections and a new government? It would seem so, but an election could take months, and would throw pressure back onto the Europeans to decide whether they should wait for a more amenable (at least in their view) government. Meanwhile, focus switched to the European Central Bank (ECB) on Sunday. The ECB has been keeping Greek banks on life support via emergency liquidity assistance (ELA). In the event, the ECB decided to continue the ELA, but not raise the limit. Given the withdrawals from the banking system over the weekend, the Greek government was forced to impose capital controls last night and to keep the banks closed until next Monday.

What does all this mean for markets? For equities, the coming week heralds plenty of uncertainty and volatility. The initial reaction on Monday reversed last week’s 5% gain. Similarly, peripheral bond spreads in Italy and Spain have reversed from the 30 basis points (bps) of tightening we saw last week. For bunds, it means the past week’s sell-off favours a new safe-haven bid. The euro is trading weaker, but not by much. The reaction of the ECB is key. With no conclusion (at least no positive one) likely this week, the markets will be reacting to headlines from the banking system, opinion polls and rhetoric from both sides to indicate whether there is a way back in the event of a no vote.

Beyond Europe, recent weeks have been the worst for the A-share market since 1996

Away from Europe, the other major story unfolding is the ebb and flow – well, pretty much the ebb – of the China bull market. After months of China outperforming, recent weeks have been the worst for the A-share market since 1996. Friday saw the Hang Seng fall 7.5%. Today, the market was down another 3.5%. H-shares are down by less, having rallied less in the past six months, but are still dropping sharply. As the Chinese economy slows, hope of ongoing easing has been a major propellant to drive equities higher. The rally has pulled in more and more retail buyers, with record margin numbers. Just as with many other things in the current China, it is becoming increasingly challenging for the authorities trying to manage the equity market. On the one hand, they have continually indicated that they want a bull market, and need to ease more to help the real economy. On the other, fear of a bubble has led to periodic attempts to rein in margin buying. As if on script, this weekend the People’s Bank of China (PBoC) cut the benchmark interest rates by 25 bps to 4.85%, the one-year deposit rate to 2%, and the reserve requirement ratio for certain banks targeting SMEs and agricultural lenders. Clearly the authorities aren’t quite ready for the bull market to be over. The market struggled on Monday, down another 3%, although it’s hard to distinguish the action by the PBoC from the general risk-off move across Asia caused by Greece. But it is clear that things will remain incredibly volatile – something that needs to be taken into account for anybody looking to buy. In our view, the risk/reward profile at this juncture doesn’t quite make sense. So there’s lots going on − lots of volatility and lots of headlines to come.

Highlights for the Week Ahead: 29 June–3 July

Economic Diary:

Monday: Japan: retail sales (May); industrial production (May); UK: mortgage approvals (May)

Tuesday: Eurozone: unemployment (May); UK: current account (Q1); GDP (Q1); index of services (Apr); US: consumer confidence (June)

Wednesday: Eurozone: manufacturing PMI (Jun); US: ISM manufacturing (Jun)

Thursday: UK: Markit construction PMI (Jun); US: non-farm payrolls (Jun); unemployment (Jun)

Friday: Eurozone: services PMI (Jun); UK: Markit services PMI (Jun)

Corporate Diary:

Companies reporting earnings or giving trading updates this week include Toshiba, Ocado and General Mills, plus more.

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Equity Markets* 26 June 2015 % Change
S&P 500 2101.49 -0.40
NASDAQ 5080.51 -0.71
TOPIX 1667.03 2.21
FTSE S&P World Europe 426.55 2.60
FTSE All-Share 3683.84 0.65
DAX 11492.43 4.10
Hang Seng 26663.87 -0.36
Eurostoxx 50 3621.37 4.79
Bonds 26 June 2015 % Change
Citi World Govt Bond Index All Maturities 684.31 -0.55
Bond yields** 26 June 2015 19 June 2015
US 2.48 2.27
Japan 0.46 0.41
Germany 0.92 0.76
UK 2.19 2.01
Currencies 26 June 2015 19 June 2015
JPY/GBP 195.01 194.99
USD/EUR 1.11 1.13
GBP/EUR 0.71 0.71
JPY/USD 123.96 122.76
USD/GBP 1.57 1.59
Commodities 26 June 2015 % Change
Oil (Brent Crude) 60.56 0.05
Commodity Futures (CRB) Index 426.86 2.04
Gold 1171.01 -2.43