Three Thoughts from London

Ilan Solot explains why Germany’s bailout negotiation victory has started to look a lot less glorious, how a very weak milk auction helped drive the New Zealand dollar to multi-year low, and why it is unclear if markets are prepared for the Turkish elections.

1/ The same way that the excitement of Tsipras’ post-referendum victory quickly faded, Germany’s bailout negotiation victory has started to look a lot less glorious as the week progresses. First, several high profile commentators and members of the international community came out condemning the “agreement” as ultimately destructive and self-serving, constructing an image of Germany as a righteous playground bully. Second, contrary to the bailout premise, the IMF openly called Greece’s debt as “unsustainable,” then said the country needed debt relief measures “far beyond what Europe was willing to consider.” Third, Britain protested against the use of its funds for the bailout, with negotiations ending with what Chancellor Osborne called an “impregnable ring-fence” around its £850 mln potential contribution. Fourth, the ECB delivered a surprise €900 mln increase of its emergency liquidity facility (ELA) to Greece, just as German Finance Minister Schäuble started to talk about a Grexit once again to the Bundestag.

2/ A very weak milk auction by the GlobalDairyTrade (GDT) earlier in the week helped drive the New Zealand dollar to multi-year low and added to speculation of a 50 bp cut by the RBNZ. For those of us who have never quite understood how this works, here are the basics. Every 15 days the GDT holds auctions for 8 dairy items ranging from butter to anhydrous milk fat. The aggregate index for this week’s auction declined by 10.7%, and the whole milk powder sub component fell 13.1%, both extending multi-year lows. This is largely due to China (largest importer) amassing a huge stock of milk powder then cutting imports by 69% ytd, and because Russia’s (second largest importer) continues a retaliatory ban on foreign dairy imports. This matters because whole milk powder accounts for 75% Fonterra’s exports. And this matters because Fonterra – New Zealand’s 10,500-farmer strong cooperative that accounts for a third of world dairy exports – makes up 7% of the country’s GDP and 30% of its exports. This single item, dairy, is so important that RBNZ mentioned falling prices as one of the three key risk to the nation’s financial stability, noting that a quarter of farmers are now operating with a negative cash flow (see second graph).

3/ We are a few steps closer to elections in Turkey, and it’s unclear whether markets are prepared for it. After the first round of coalition building, PM Davutoglu concluded that the nationalist party MHP won’t be participating in a coalition government. What is more, he also said that the likeliest option was the CHP, the traditional opposition party – we very much doubt this would work. As we highlighted in our report last week Political Risks Rising Again in Turkey and Brazil, the demands made by the opposition are too unpalatable for the ruling AKP party to swallow. Despite today’s comments by the PM, we still think the Kurdish HDP party is the least unlikely candidate for a coalition, but an agreement still doesn’t seem forthcoming. It looks as if AKP may just be making a token effort at negotiating, while really aiming for new elections. If so, the question is what do the AKP and President Erdogan have up their sleeves to change the results of the electoral stalemate? And are markets prepared for it? Our guess is that they are not.