- Capital Markets to remain on alert all week
- Greece sees creditors demands as “irrational”
- Euro periphery yields rally on possible contagion
- Lack of rate and growth divergence not helping USD bulls
No matter what transpires this week in capital markets, investors are required to trade with some caution as price movements across the various asset classes – forex, fixed income or equities – are expected to be rather volatile.
Already, failure between Greece and its creditors to reach an agreement over the weekend has translated into a decisively apprehensive start to the week with asset class prices gyrating on news and innuendo.
Greek PM Tsipras said that he would not accept demands for cuts to pensions and wages or a rise in value-added tax on electricity, calling his countries creditors’ demands “irrational”. However, Greece’s alternative plan again comes up €2b short annually of what has been demanded by its creditors, thus making the target of a primary surplus in Greece an unattainable goal.
The rest of Europe again sees Greece’s proposals as “vague and repetitive” and they are rapidly losing patience. As per usual, negotiators are again kicking that ‘can down the road,’ passing the buck to Thursday’s Eurogroup meet ahead of the more formal Ecofin gathering on Friday.
Greek matters have led the major Asian and Euro bourses lower, sovereign debt prices higher and euro periphery bonds to tumble, while keeping the EUR susceptible to sharp price moves. Greek 2-year bond yields have backed up +2.5% to +27.4%, while the German 10-year price has rallied to yield +0.81% well off last week’s high yield of +1%.
Expect fixed income traders to be keeping a close eye on Spanish and Italian debt product in particular, as they could be the most affected by a Greek default. The thought is, that if Greece were to default or exit then it might encourage other weak euro members to seek the same. Currently, Spanish and Italian bonds are yielding higher, around +2.30% and +2.28% respectively.
Investors risk appetite to be put to the test
It’s only natural that the unfolding Greek drama is threatening investor risk appetite. Ongoing Greek concerns have again managed to pressure the Euro currency and send peripheral yields higher. The single unit briefly tested below the €1.1200 in the overnight session, as it quickly cleared out weak stop losses parked ahead of the psychological support level. The lack of upward momentum for the single currency leaves last Friday’s EUR low (€1.1151) rather vulnerable. However, if the EUR bulls are able to successfully defend the support levels could lead to a recovery back to Friday’s intraday high of €1.1296. Nonetheless, current momentum does not seem to favor that move as the market moves stateside. Obviously, a loss of key support would alter the EUR picture rather quickly, and backing for the EUR bear to revisit the €1.10 handle.
Will Ms. Yellen give anything away this week?
Aside from Greece, the first real focus for investors this week will be the FOMC events this coming Wednesday. No one expects the Fed to be changing rates, but will U.S policy makers likely make any changes to their quarterly economic forecasts? Markets players are expected to get very trigger-happy around the Fed Chair’s Wednesday press conference. Everyone is looking for hard evidence of when U.S rate normalization will begin. Will Ms. Yellen mention September as the likely month for action?
From a big picture perspective, over the past three-month the USD remains stuck in well-defined trading range against the EUR (€1.05-€1.15), influenced mostly by risk on or off. From a rate perspective, it feels like the dollar has already priced in fully its rate differentials. Yet, dollar bulls continue to look for stronger evidence to support adding or holding current dollar positions. But, are they getting jaded?
From a growth perspective, the U.S economy, while showing signs of strengthening, is growing more slowly than expected while growth in Europe is showing signs of gathering momentum. Already, some investors are beginning in earnest to start pricing in the possibility that Euro policy makers may be less inclined to keep the market flooded with liquidity right up to September 2016. If true, this will obviously cap the dollar’s gains.
It’s interesting, that despite stronger May non-farm payroll (NFP) numbers, German Chancellor Merkel talking down the EUR and stronger U.S retail sales data last week, the dollar is finding it difficult to gain much traction. This would suggest that dollar bulls are apprehensive about adding new dollars to current positions due to market uncertainty. The risk/reward just does not seem to be there.
Perhaps the strength of the dollar’s current attraction reflects investor’s uncertainty about how aggressively the Fed can tighten monetary policy, especially during an uneven economic recovery. Both wage growth and inflation remain tepid at best.
Making it more difficult for the USD bull’s cause is the IMF and World Bank both having expressed that the Fed should postpone raising rates, at least until 2016. Gradual movement by the Fed will only temper USD gains. It’s no wonder that investors are looking to other currencies, like GBP and Yen for value, especially as U.S and Euro rate and growth divergence was supposed to be so much stronger.