The Calm Before the Storm?

The global capital markets remain subdued for the most part despite the fact that paralysis in Europe is bringing Greece to the very brink. There will be no agreement today, and the finance ministers will meet again tomorrow in what Merkel and Hollande have called a "decisive meeting."  The implicit threat is that if no agreement is reached, officials will begin preparing for a Greek default.  

The IMF is doing its part to keep the pressure on Greece.  One does not default to the IMF.  If a payment is missed, a country falls into arrears. IMF guidelines are for it to immediately send a letter asking for prompt repayment and cutting the country off of any IMF assistance.  If no payment is forthcoming, the IMF board is notified of the situation in a month.  A spokesperson for the IMF indicated that due to the "visibility" of the Greek case, that the board would be notified promptly.  

However, the rating agencies have indicated that the failure to pay the IMF will not be a formal default. As Moody's explained, according to a press report, a default is a missed payment to private investors.  At the same time, the ESM could, at its discretion, demand an accelerated repayment schedule by Greece, which would, of course, further complicate the situation.  

There are no winners here.  Greece's economic situation is deteriorating.  The government is in arrears to its suppliers, which further squeezes the private sector.  The deposit flight is further weakening the already fragile financial sector.   The whole episode does not reflect well on European and IMF leadership.   The situation has festered not simply since Syriza was elected.  In some way that was already a sign of crisis.  It failed to reach an agreement a year ago with the former government formed by the two main traditional parties New Democracy and Pasok.   Even if the official creditors want another regime change, what does that mean?  Golden Dawn?  

The creditors previously forced Ireland to bailout subordinated bank bondholders.  It forced Cyprus to bail in depositors.  Many see their hand in forcing Berlusconi's resignation, which has been followed by three unelected prime ministers in Italy.  The creditors have shown that behind the facade of rules is shrouded in discretion.   The extensive discretion undermines the legitimacy of power and European leaders. 

The markets are taking the approaching brink in stride.  The foreign exchange market is quiet.  The majors are confined to recent ranges.  The dollar-bloc is softer. Peripheral bond yields are a few basis points higher while core bond markets are little changed.  Equity markets are lower.  European bourses are trimming this week's gains.

The sharp losses seen in Chinese stocks are the main exception to the generally subdued tone. The 7.8% drop in the Shanghai Composite brings the loss since June 12 to 19%.  While many, want to blame Athens for everything these days, Chinese stocks are marching to their own tune.  The two-week loss is the largest in 18 years.   Reports indicate that as many as 820 of the 1105 companies listed on the Shanghai Exchange lost more than 9.5% today.  

Chinese share losses are limited to 10% a day.  The 30-day volatility has jumped to near 50%, the highest since the H2 09.  The unwinding of margin borrowing, the tighter liquidity conditions, the absence of new stimulative measures are widely cited as factors.  Often, it seems that after an incredible rally that stretches valuation beyond recognition, it does not take a significant shock to trigger a reversal.  

Japan reported CPI, household spending, and unemployment.  Core inflation in May, which in Japan excludes fresh food, rose 0.1% year-over-year.  This was little above expectations but down from 0.3% in April.  The June Tokyo core CPI matched expectations of 0.1%, but this was down from May's 0.2% reading.  Despite inflation well below the BOJ's target, those looking for additional stimulative measures have pushed out expectations into the second half of the fiscal year.  

Separately, Japan reported unemployment was unchanged at 3.3%, which matches the low since 1997 though the job-to-applicant ratio rose to 1.19 from 1.17.  The best news, however, came from household spending.  It rose 4.8% year-over-year.  This is a third more than the market expected and ends the 14-month run of negative readings.  

Without spurring much of a reaction, the ECB reported that M3 money supply growth slowed to 5.0% from 5.3%.  The consensus expected a small increase.  The credit details were better.  Private sector credit extension rose 1% in May from 0.8% in April.  Lending to households continued to slowly improve (1.4% from 1.3% year-over-year), but the more important news is that lending to non-financial businesses showed the first positive reading (albeit 0.1%) after contracting for the better part of the past three years.  

Lastly, we note that the smaller than expected Swedish trade balance (the SEK2.3 bln surplus was half of the revised April surplus), but especially the unexpected weakness in retail sales (-0.1% rather than the consensus expectation of a 0.3% gain), reinforces expectations that the Riksbank will likely boost its bond buying program at next week's meeting.  It is little changed today, but the krona is the weakest of the major currencies this week, losing about 1.8% against the US dollar.

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