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.
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.
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.
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.
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.
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.
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.
We’ve read a lot of commentary about the risks of political contagion in Europe and how the Eurozone could fall prey to a leftist insurgency that could sweep through the European periphery, spiral out of control, and destroy the European project. In that narrative, Spain is considered to be the next shoe to drop, with the Podemos party seen as sharing the same political ideology as Syriza. With Spanish elections in December, understanding the real risks will be crucial for markets. Unicredit‘s Edoardo Campanella has just written a piece that rejects the above narrative. Podemos does not pose a systemic threat to the stability of the Eurozone. They may share similar views on EU policies and they may have supported Syriza’s confrontational negotiations with their creditors, but back on home turf they have taken a different approach, writes Campanella. Since the regional elections in May Podemos has proved to be a more responsible political force than Syriza, showing a willingness to compromise and interact with the old establishment. Campanella also provides a very detailed account of the machinations of the Spanish politics, the implications for the upcoming elections and the role Podemos will play.
In amongst the white noise of Greek headlines you may have missed this yesterday. In what was considered a surprise move, the ECB further expanded the list of QE-eligible assets to include 13 new agencies. Some of which are de facto corporate names (Although partially state-owned). BAML put out this piece entitled: ‘’ECB: Still finger on the trigger.’’ Gilles Moec and Ruban Segura-Cayuela write that although the decision to expand the list was a symbolic one (100 billion euros), it does give credibility to recent speeches from the Governing Council arguing the ECB can do more. It’s a short piece, but it makes a great point about how the ECB stands ready to pull the trigger on more QE just in case some of the recent moves in markets are more persistent than they anticipate. That’s even more important now than ever as the Greek crisis hangs over the market’s head.
As the risks around growth falling to zero coincide with the possibility that CPI inflation heads to 3, the RBNZ will most surely have a fun time ahead of it, writes Stephen Toplis, head of research at the Bank of New Zealand. The RBNZ has been a one of the busiest central banks over the past 12-18 months, and in both directions. It was one of the first developed-market CBs to raise rates, and then had to switch to an easing bias in relatively short order this year as the economy ran out of steam. BNZ has held a pretty bearish view on GDP for a while and in this piece they point out that the rest of the market is now in the process of downgrading GDP forecasts. More easing is on the cards too, as plummeting dairy prices and construction activity from rebuilding Christchurch peaks and feeds through into the wider economy. The problem the RBNZ now face is rising inflation which has now risen well above the RBNZ’s own forecasts, as the NZD has collapsed. Toplis and his colleagues do a fantastic job at articulating the classic dilemma that central banks of small open economies face in managing policy.