China weighs on AUD; NAB lowers forecasts

The Reserve Bank has held off cutting interest rates at today’s meeting, as expected, and its statement is largely unchanged from its June statement with further depreciation of the currency as “both likely and necessary…given significant declines in key commodity prices.” Prior to the announcement NAB lowered its forecasts for AUD where they have defined a new trading range of .7000-.7500. Obviously, as a risk currency, AUD is likely to come under pressure should the Greek situation deteriorate, but NAB reckon China probably represents as big or a bigger risk for Australia than development in the Eurozone. If Chinese equity markets fail to stabilise, there is the potential for negative wealth effects that impact everything from tourist arrivals to Chinese demand for Australian real estate (as well, as potential for further weakness in key commodity prices if domestic demand growth slows further).

Why a Greek deal is too high a price to pay

Graham Bishop from is a renowned technical expert on all political-economic aspects of the European Union and remains a strong advocate of greater integration of Europe. However in his most recent piece he argues the implications of Sunday’s ‘’No’’ vote, and the possibility of a final hour deal with European creditors could lead to the permanent destruction of any credibility for the euro area’s economic governance system. In this piece he explains quite simply why doing a deal with Greece is too high a price to pay, and that Europe should not pay. The headline to the piece says it all: ”Greek-style democracy: 4 million vote each Greek elector a [€20,000] present from the other 250 million euro area electors.”

Plenty of risk aversion before the firewalls kick in

While the investor community is in the process of recalibrating the odds of a Greek exit from the Eurozone, implying further risk reduction, there is too much focus on the various firewalls that have been put in place to avoid contagion, writes Neil Azous from Rareview Macro. The risk is that before these firewalls are reached there’s still significant scope for a draw down in asset prices (perhaps as much as 10%) that can hurt returns. In this piece he points to key technical developments since the end of last week to drive home his point. European equities (which have just broken through key technical levels on the downside), and the a 180 degree turn in the Eurodollar futures market since Thursday’s payroll data that have now priced out any Fed rate hikes in 2015. The report also mentions the vulnerability of Japanese equities.

Trimming European equity exposure

As we have touched on above, European equities have experienced risk aversion in the wake of the resounding no vote over the weekend, and some further risk reduction is further required. MRB published this asset allocation piece yesterday that we thought worth noting. It’s a temporary tweak rather than a strategic shift, where they downgrade euro area stocks and periphery government bonds awaiting a policy response from both Greek and European authorities. European equities are lowered to neutral in their global equity portfolio, while US stocks are temporarily upgraded to neutral. As for bonds, in a short-term tactical response, MRB are temporarily shifting from maximum underweight to underweight until the policy backdrop becomes clearer. Beyond the short term, they remain confident that contagion from Greece will be contained and the euro area economic recovery and global economic expansion will remain on track. Hence, they maintain their overweight stance on stocks versus bonds in a global multi-asset portfolio on a 6-12 month horizon, and expect to reverse today’s allocation changes in due course.

Fed hikes still on track

While futures markets price out the prospect of one-full rate hike in 2015 (See Rareview piece), Medley’s Regina Schleiger published this note yesterday arguing that the Fed is on track to raise rates in September, which is likely to be affirmed in tomorrow’s FOMC’s published minutes. Schleiger reckons the minutes will show members generally more upbeat about the US outlook than their June Statement of Economic Projections conveyed. That ought to go some way to contradicting the market’s dovish action reaction to those lowered projections and a shallower path for Fed funds, Schleiger argues. It’s a well-reasoned report that covers all of the bases and gives the reader some context on the lowering of the ‘’dot plot’’ in June. This is probably more about the committee’s desire to maintain some optionality beyond the first rate hike, which the markets may have misinterpreted if recent price action is anything to go by.


The eurozone is not on the brink

How will the rest of Europe likely respond to a radical and unrepentantly defiant Greek government, now vastly strengthened by its mandate from the voters? Asks Anatole Kaletsky from GavekalDragonomics. Normal EU practice would suggest an obscure bureaucratic compromise, but yesterday’s vote obviously makes that more difficult given the Greek government’s strong mandate not just to persist with the previous political intransigence but also to demand big concessions from its creditors. At the same time, European politicians could not be seen to now buckle under these demands because of the domestic backlash that would result. Kaletsky argues that the EU will probably do as little as possible for as long as possible with regard to Greece in the hope that Tsipras might change his attitude. This piece argues that the focus will on the Europeans (ECB, EC and German government) will devote themselves to stabilising markets and offering discrete fiscal concessions to Portugal, Spain, and Italy to strengthen incumbent governments and to discourage the eurosceptics.

The Greek government will fall within weeks

That’s the view of Unicredit global chief economist Erik Nielson, writing in his weekly Sunday note to clients. History shows fragile coalition governments do not last long in rapidly shrinking economies. And there is no plausible scenario, which will stabilize the Greek economy in the short term, he writes. The outside probability of “the mother of all rescue packages” from the rest of Europe and the IMF seems inconceivable, certainly so long as the present government (and indeed parliament) is in power. Neilson’s note also addresses the prospects of whether critical payments by Greece can be made on July 20, and whether the bureaucracy can hold itself together to action these. He isn’t that optimistic. He also looks at the likelihood of a parallel Greek currency (maybe first as IOUs) but they are unlikely to succeed, given that this government is struggling with even the most elementary logistical things. He also addresses the structural solution to the Greek crisis – greater integration of Europe and more institution building – where he argues that the sad irony is that a Greek collapse is more likely to trigger a leap forward in Europe, than the current muddling through.

Gregression: Which assets are most sensitive to Grexit

Published late last week, UBS provide some useful modeling analysis on potential Grexit based on last Monday’s price action in response to the surprise calling of the Greek referendum. They compare Greece risk sensitivity in two ways (i) the “shock” response to the weekend referendum announcement and (ii) beta found by regressing asset returns against peripheral spread during 2012. Amongst equity indices the surprise was that some EM countries such as India and Russia were only weakly correlated with European woes and offered some diversification. European sectors that held up best were the standard defensives such as Health Care and Consumer Goods but not Utilities. We do realise that things have changed since this time last week given that the probability of Grexit has now increased substantially, but in relative terms these regressions are something to bear in mind as markets up this morning.

Too Big To Fail: China stock market at critical juncture

With a generation of the middle class’s wealth at risk, and confidence in the financial system on the line, Xi & Li are facing the toughest challenge since they took office, writes the Jefferies equity strategy team in Hong Kong. They believe the A-share market has become the ultimate stage for political and economic power struggles. With reform and the China dream at stake, this is a battle China cannot afford to lose. They highlight the measures announced over the weekend (including 28 IPOs halted and the creation of a broker stabilization fund to buy blue chip ETFs), as well as other measures that will likely be announced in the near future to restore confidence and prevent a systemic crisis. It will take some time to stabilise, but Jefferies believe that an uptrend can resume and in this report they outline their 12-month targets and their top picks based on fundamentals.

Oil inventories set to rise again

In case you missed it the best performing asset class in the first-half of 2015 was oil. The commodity might struggle to repeat that performance in the second-half however. That’s because oil market fundamentals remain distinctly bearish, writes Harry Colvin from Longview Economics. Colvin outlines 3 key pillars to this bearish view, but really catches the eye in this report is Longview’s forecast for global oil inventories, which are almost double the EIA (consensus) forecasts for the end of 2016. Why? Longview’s model assumes US shale output is unlikely to fall meaningfully, based on current prices, at least until oil prices move lower again to force a shale oil supply response. The report goes onto explain what this means for the oil curve, and they have some interesting insights on current positioning too. Oil could test the March lows again, Longview conclude.