Cautiously Anticipating a Greek Deal

In this edition of CurrencyView, we discuss what to expect from the Greece deal, Australia’s better than expected job numbers and the latest from the Bank of England, China, Korea, Mexico and Peru.

  • We suspect that many misunderstand the incentive structure, and under-estimate the political will to ensure EMU remains irreversible
  • The FOMC minutes took on a cautious tone; the one surprise perhaps was the attention paid to developments abroad
  • The Bank of England meets but this is a non-event
  • The latest measures by the Chinese government to stem the bleeding seemed to have worked, for now at least
  • Australia jobs numbers were better than expected; Japan May machine orders and June machine tool orders both rose quite smartly
  • Mexico reports June CPI; Peru central bank meets and is expected to keep rates steady at 3.25%

Price action: The dollar is mostly firmer against the majors in fairly quiet trading, with the yen the biggest mover. The dollar was unable to hold below the ¥121 level and is now back to ¥121.50. The euro rose to nearly $1.1150 overnight, but has since fallen back to trade near $1.1030. The pound is outperforming but meeting resistance at the $1.54 area. Better-than-expected employment data out of Australia did little to the Australian dollar, trading flat near $0.7430 now. In the EM space, RUB is outperforming as oil prices stabilize, and the same goes for MYR. EM Asian indices were mixed, but the Shanghai Comp bounced by 5.8% on the back of more government support. The Nikkei was up 0.6%. MSCI EM is up 1.5%, the first gain after six straight down days. EuroStoxx 600 is up 1.6% near midday, and US futures are pointing to a higher open. Fixed income markets are mixed and mostly quiet, with US Treasury yields up 5 bp and EU periphery yields down 5-10 bp. Crude prices are up about 1% and iron ore prices futures are up 3.0%.

  • We suspect that many misunderstand the incentive structure, and under-estimate the political will to ensure EMU remains irreversible. In 2011-2012, the betting odds that Greece was going to leave EMU were reportedly as high as 70%. We argued then and continue to believe that key considerations may be outside the financial and economic calculus investors are so familiar with. Many observers do not appreciate Draghi’s insight that the monetary union is first and foremost a political union. There is much determination at the highest levels of Europe to preserve the integrity of the monetary union. Of course, there are dissenting voices in nearly every country, and many are exasperated with the Greek drama.
  • However, the commitment toward the European Project, for the lack of a better name, is palpable. There is no Plan B. There is either continued progress toward integration or European nationalism returns threatening a return to pre-modern times. It is, as we are fond of noting, as Benjamin Franklin told the thirteen colonies on the eastern seaboard of North America as they fought the world’s greatest empire of the day: “We hang together or we hang separately.”
  • On that note, the headline of the day was the IMF and the US are increasing pressure on the EU to grant debt relief to Greece. This lends credibility to Tsipras’ arguments, but we are not sure it helps very much. In fact, it may even be counterproductive if it means that Germany is seen as capitulating not only to Greece, but also to the US.
    Separately, the ECB maintained its ELA funding for Greece yesterday at current levels. Afterwards, Greece announced that its banks would stay closed until Monday. The country has until midnight tonight in Brussels to submit a package of measures that might unlock a new aid package. EU leaders will meet Sunday to craft their response to Greece’s proposals. The ECB will then meet on Monday to consider its response.
  • The FOMC minutes took on a cautious tone. While the FOMC saw conditions still approaching those warranting lift-off, “many” officials wanted more proof that growth was strengthening enough to hike rates. A “number” of officials cautioned against a premature hike. On the other hand, “some” Fed officials said conditions for a hike had been met or would be met shortly, and one member was ready to hike in June but was willing to wait. As we have noted before, the minutes contain a lot of noise, with a clearer signal seen in the policy statement itself.
  • The one surprise perhaps was the attention paid to developments abroad, with “many” officials expressing concern about Greece. “Several” voiced uncertainty about China’s growth. Since the June 17 meeting, developments in those two countries have worsened. At this point, we think China and Greece won’t impact Fed lift-off, but much depends on how well the two situations develop in the coming days and weeks.
    The Bank of England announces its decision shortly, but this is a non-event. Although attention has been paid to a few hawks on the MPC, it is unlikely that anyone will vote for a hike now. When it does nothing, it says nothing. Minutes to this meeting will be released July 22.
  • The latest measures by the Chinese government to stem the bleeding seemed to have worked – for now at least. The one that’s getting the most attention is the new regulation blocking large shareholders from selling for the next six months. Also, the government eased restrictions on senior management and major shareholders to increase holdings. The Shanghai Composite rose nearly 6%, the biggest one-day gain since 2009. Separately, China’s June CPI and PPI for June came in close to expectations at 1.4% and -4.8% y/y, respectively. Elevated food prices pulled the CPI index a bit higher. PPI has been negative for the last 39 months. So the bottom line is that inflation trends offer no resistance for the government to continue in its easing trajectory.
  • Australia jobs numbers were better than expected. Total jobs rose 7.3k vs. flat expected, and the details were good. Full-time jobs rose 24.5k, while part-time jobs fell -17.2k. The unemployment rate fell to 6.0%. Along with improved China sentiment today, the Aussie has stabilized a bit just above the .7400 area. Further losses are expected, however, after it set a new cycle low yesterday around .7370.
  • In Japan, May machine orders and June machine tool orders both rose quite smartly, by 19.3% y/y and 6.6% y/y, respectively. Elsewhere, Economy Minister Amari noted that the excessively strong yen has been corrected, and that Japan hasn’t intentionally been guiding the yen lower. For now, it seems that the 120-125 range remains intact and Japan officials seem quite content. However, if the broad-based dollar rally continues as we expect, we will move into a higher range for dollar/yen eventually.
  • Bank of Korea and Bank Negara both met earlier today, and both kept rates steady, as expected. The most notable development here was the updated forecasts by the BOK. GDP growth was cut to 2.8% for 2015 and 3.3% for 2016. Still, recent comments by central bank officials suggest that they are in no hurry to cut, and that the fallout from the MERS is unlikely to sway them. There does appear to be some fiscal stimulus in the pipeline, and the recent rise in the JPY/KRW cross will also help at the margin.
  • During the North American session, the US reports weekly jobless claims. The Fed’s Kocherlakota spoke earlier in Frankfurt, while Brainard and George will speak later today. Canada will report June housing starts and May house prices.
  • Mexico reports June CPI, expected to rise 2.89% y/y vs. 2.88% in May. June ANTAD retail sales will also be reported, expected to rise 4.8% y/y vs. 7.4% in May. It reports May IP Friday, expected to rise 0.5% y/y vs. 1.1% in April. With inflation below the 3% target and the economy sluggish, Banco de Mexico will be hard-pressed to deliver a rate hike this year. We see steady rates for the time being.
  • Peru central bank meets and is expected to keep rates steady at 3.25%. CPI inflation accelerated to 3.54% y/y in June from 3.37% in May, putting it further above the 1-3% target range. So despite the sluggish economy, rising inflation should keep the bank on hold for the time being. Lower copper prices are complicating matters, and appear on track to testing the cycle lows from January.