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IronFX Daily Commentary | 29/06/15

29.06.2015, 9am

• Greek drama takes a sudden turn for the worse Don’t underestimate the role of pride in international relations. Sometimes people and indeed entire countries make decisions that are not in what appear to be their best interest simply because of pride. That seems to be what has happened in Greece. PM Tsipras called the last creditors’ offer “humiliating” and refused to sign. Instead, on Friday evening he called a referendum for 5 July to let the people vote on it, while urging that the country reject it. “The dignity of the Greek people in the face of blackmail and injustice will send a message of hope and pride to all of Europe,” he said in a statement that focused more on emotions than on economics.

• Some people argue though that the reason he called a referendum had more to do with domestic politics. That is, he may have realized his coalition wouldn’t pass the agreement so he needs the backing of the voters to force it through parliament.

• In any event, the EU and the IMF have lost patience with Greece. They refused Tsipras’ request to extend the nation’s bailout program, which ends Tuesday, to at least until the ballot.

• Caught between the politicians and the risk of a financial crisis, the ECB tried to steer a neutral course and will keep the level of Emergency Liquidity Assistance (ELA) funds to the Greek banks unchanged. That is, they are not going to pull the plug, but neither are they going to ease the pressure by increasing the ELA to compensate for further cash withdrawals by the Greek people. “The bank deposits of the Greek people are fully secure,” Tsipras said in a televised statement. “The same applies to the payment of wages and pensions – they are also guaranteed.” Nonetheless, the country closed its banks and will not reopen them until July 7th at the earliest and imposed capital controls while limiting daily cash withdrawals to EUR 60.

• My view: “yes” vote is likely, but you never know Personally, I always thought a referendum was the likely conclusion, but I assumed that they would hold it before the deadline. By waiting until now, the Greek government has crossed several red lines: they will exit from the bailout program without another program set up and they probably will not be able to make their payment to the IMF Tuesday. Neither is good. If the country rejects the offer in the referendum, then probably they will have to leave the euro, which I think would be a disaster for the currency (see below). My view though is a week of having the banks closed will give them a taste of what life would be like outside the Eurozone. As a result, I expect them to vote “yes” and accede to the creditors’ demands, which will probably mean a change of government.

• Nonetheless, you never know. First off we don’t know how the referendum will worded. Lots of research has shown that the answer you get depends to a large extent on the question you ask. If they only ask whether you agree with the creditors’ proposal, as seems likely, many people may vote “no” without realizing that a “no” vote implies exiting the euro. Secondly, as we saw with PM Tsipras, pride is a strong motivating factor. Look at Russia – how popular PM Putin is despite the difficulty caused by the sanctions, because he has made the world take Russia seriously again! The idea that it’s better to die on your feet than to live on your knees has a lot of resonance. I expect that Greek voters will feel that they are Europeans and that they need to do whatever is necessary to remain in Europe, hence vote yes; but it’s entirely possible that they will feel they have nothing left to lose and vote “no” to regain their pride regardless of the consequences.

• Why Greece leaving the euro would be a disaster Greece is just a small part of the Eurozone. Furthermore, it’s a troubled part. Some people believe that the group would be better off over the long term without it, like taking a pebble out of your shoe. Certainly the Eurozone would have been better off if Greece had never joined. However, having joined, the question is not whether the Eurozone would be better with or without Greece; the question is whether a country can leave the euro. If a country, any country, can leave the euro, then investors in European assets have currency risk that they didn’t have before. Any German or Dutch investor holding Portuguese or Italian or Spanish assets suddenly has a new risk to hedge. The market cap of the Italian stock market is around EUR 600bn. If investors hedge even 10% of that, it’s EUR 60bn outflow, a significant amount. Spain is even bigger. We also have to wonder if residents of these countries will look at Greece and think, maybe we’re next? And start to move their money out of the country too. That would be negative for the euro as well.

• ECB to the rescue The ECB is likely to be in the market to prevent such contagion. It said in its statement that “The Governing Council is closely monitoring the situation in financial markets and the potential implications for the monetary policy stance and for the balance of risks to price stability in the euro area. The Governing Council is determined to use all the instruments available within its mandate.” In short, the ECB will do “whatever it takes” to contain the Greek risk, prevent contagion and protect the Eurozone as a whole. As we saw in 2012, sometimes mere words from the ECB are enough to restore confidence, and indeed the relatively muted move in the FX market today (EUR/USD down 1.6% at the European opening, a big move but still well within its recent trading range of around 1.09-1.14) may reflect confidence in the ECB’s ability to contain matters.

• Besides jawboning, the ECB has many tools that it can use to prevent contagion. These include:

  • Frontloading its bond purchases within the context of the QE program, i.e. increase the size of the monthly purchases for the time being
  • Buying more of the bonds of vulnerable countries, such as Italy, Spain and Portugal
  • Offer special liquidity injections if some parts of the Eurozone suffer from a severe shortage of liquidity
  • Finally, it could activate the “Outright Monetary Transactions” (OMT), a program that the ECB instituted in 2012 to allow it to buy bonds of troubled countries in the secondary market without limit.

• Japan’s industrial production falls; yen strengthens Japan’s preliminary industrial production for May showed a larger-than-expected fall as production of cars slowed. The negative impact on stocks was amplified by the Greek news, which hurt companies that export to Europe. As stocks fell and risk aversion set in, the yen strengthened as usual. This morning it’s the only G10 currency that’s significantly stronger vs USD than it was Friday morning.

• COT report shows plenty of room for new EUR shorts Briefly, Friday’s Commitment of Traders (COT) report showed that investors increased their short EUR positions during the week. Nonetheless investors are not exceptionally short, with the latest reading being only the 32nd percentile. There’s plenty of room to increase EUR shorts. The speculative market’s NZD position is now historically extreme, but relatively small on both an absolute basis and relative to the net long positions the market has had in the past (some 30k contracts maximum). Against the background of further room for easing in New Zealand, I think there is room for NZD shorts to expand further into record territory.

• Today’s highlights: During the European day, the German CPI for June is coming out after several regional states release their data in the course of the morning. As usual, we will look at the larger regions for a guidance on where the headline figure may come in, as an indication for the near-term direction of EUR. Following the introduction of the QE program by the ECB, the German CPI as well as the Eurozone’s CPI had less impact on EUR than usual, because ECB policy is basically on auto-pilot until the QE program ends in Sep. 2016. However, there’s also the question of when they will start to raise rates after QE ends. If the inflation rate shows signs of approaching the ECB’s 2% target, then investors are likely to bring forward their expectations for when the ECB will start raising rates. That would have an impact on the currency markets. Market expectations are for the change in prices to accelerate on a mom basis but decelerate on a yoy basis. But of course today will be dominated by Greek concerns, not economic fundamentals.

• From the US, we get pending home sales for May. Existing home sales beat expectations last Monday, therefore, we could see another positive surprise from pending home sales. This could be USD-positive.

• On Tuesday, as mentioned above the spotlight will be on Greece’s payment to the IMF, which looks doubtful at this point. As for the indicators, we get the final estimate of the UK GDP for Q1. The final figure is expected to be revised up again to show a better pace of growth than the +0.3% qoq at the 2nd estimate. This is likely to strengthen GBP a bit.

• On Wednesday, the Bank of Japan releases its quarterly Tankan business confidence survey for Q2. This is the most important indicator that comes out of Japan and so will be closely watched. All the indices for larger companies and the small companies are expected to increase a bit or remain unchanged. This could be a favorable result for Japanese stocks, which are trading at their highest level since 1996 as measured by the Nikkei index, and could push USD/JPY towards the psychological 125 level again.

• In the US, the ADP employment report for June is coming out, this time only one day ahead of the nonfarm payroll release as US markets will be closed Friday due to the US Independence Day holiday on Saturday. The ADP report is expected to show that the private sector gained more jobs in June than it did in the previous month. That would suggest a strong nonfarm payroll figure as well and boost the dollar.

• On Thursday, the main event of the day will be the US nonfarm payrolls! The market forecast for June is for an increase in payrolls of 225k, below the 280k in May. Nevertheless, another reading above 200k would indicate that the US labor market continues to improve. A strong figure is likely to strengthen USD.

• Besides the NFP, Sweden’s central bank holds it monetary policy meeting Thursday. At their last meeting, the Bank surprised the market and left its official cash rate unchanged at -0.25% but expanded its QE program by SEK10bn-20bn. Strong data recently and the unexpected rise in Sweden’s CPI rate in May take some pressure off the Riksbank to take any further action at this meeting.

• On Friday, we get the final service-sector PMIs for June from the countries we got the manufacturing data for on Wednesday being released. As usual, the market reaction at these releases is minimal as the final figures tend to confirm the preliminary readings.


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