All eyes yesterday remained transfixed by unfolding events in Greece, with IMF Special Adviser Zhu fanning the flames of fear by remarking that he was very concerned by the dramatic change that had taken place in the previous 24 hours. Renewed political instability in Greece and the image of violent protests against new austerity measures in Athens the previous day were reminders that obtaining internal agreement on EU/IMF demands was looking decidedly dubious. Some brief respite emerged yesterday as it became clear that the IMF would shell out the next tranche of Greek aid, happy that Europe had provided sufficient comfort that Greece would be funded for the next year. That said, for the pessimists the sight of the IMF backing down was not encouraging. There was also a suggestion that Germany may push for a delay to a second rescue package for Greece until September, to provide more time to reach agreement on burden-sharing. Unfortunately, the financial markets are not in any mood to give Europe more time, with Greece’s demise rapidly infecting other eurozone sovereigns. For instance, the Spanish 10yr yield widened by a further 17bp vis-a-vis Bunds to 275bp, not surprising given the heightened protests outside the Catalan Parliament on Wednesday. Greek 5-yr CDS jumped another 125bp at one stage yesterday to a new record 1,850bp, Portuguese 5-yr CDS soared by 44bp to 833bp, and Irish 5-yr CDS rose 34bp to 805bp. All in all, it was another day when risk was lowered, with the euro, equities, commodities and G4 bond yields all lower and the dollar in the ascendancy. The Aussie fell below the key 1.05 level for the first time in two months, the Kiwi dropped under 0.80 and cable fell through 1.61.
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Commentary
Greek cabinet reshuffle. The PM is due to announce a new cabinet today as part of the current reshuffle and there are rumours that former ECB vice-president Papademos may become the new Finance Minister. He won’t be able to perform miracles, but will garner far more respect and support internationally than the previous incumbent. Nevertheless, the political hurdles to approving the next round of austerity, which even the PM’s own party are not fully supportive of, remain immense.
UK retail sector still in recession. If we look at underlying sales (ex-auto fuel), then over the past six months, sales have fallen 1.2%, so that’s comparing November last year to now. If we look back through history, it’s unprecedented for the retail sector to be in recession and the rest of the economy to be holding its head above water. Therefore, the question is whether the other sectors of the economy are going to take up the slack, in other words buck the precedent of retail recessions as precursors to overall recessions. By all accounts, King’s remarks on Wednesday suggest that he is not hopeful that this can happen in the short term, suggesting that rebalancing “will take several years to complete”. For now, it seems that the consumer sector has rebalanced, but the rest of the economy (net trade, investment) is some way off doing its part on a sustained basis.
SNB holds fire on rates. Against the backdrop of recent speculation that they might be tempted to tighten, the Swiss National Bank has decided to hold fire for now. As a result, its target range for 3-mth Swiss franc Libor is unchanged at 0.0-0.75%, with the more specific aim remaining towards the bottom of the range at 0.25%. Talk of a rate move from the SNB had diminished slightly in recent days, given the continuing strength of the currency. For instance, the franc recorded yet another record high against the euro today. Staying its hand on rates is a reduction in their forecast for inflation for next year and the year after. In May, core inflation in Switzerland was unchanged. The Swiss franc has been relatively unaffected by the news – for now, the main focus is on developments in Europe’s debt crisis, which continues to stimulate demand for the Swiss currency.
US fiscal deficit talks making good progress. Europe’s debt crisis has certainly been the major catalyst for the dollar’s improvement over the last couple of days, but some traders and investors have also been encouraged by positive signs emerging out of critical talks on US fiscal policy. Vice-President Joe Biden has been holding bi-partisan discussions with key Congressmen, with last night’s meeting focusing on triggers to control deficits and spending. On Tuesday, Biden suggested that the aim of the group was to complete a budget agreement by the end of this month, in the hope of presenting a package to the President and congressional leaders prior to the 4th July recess. Biden is aiming to put together a deficit reduction plan that results in $4trln of saving over a ten to twelve year period. Apparently, agreement has already been secured on well over $1trln in saving. Republicans have linked their vote for raising the debt ceiling to the implementation of meaningful fiscal consolidation measures. Should Biden succeed in delivering a creditable fiscal plan which is then adopted by the Congress and signed off by the President, then this would no doubt provide the dollar with a boost.
India’s continuing battle to contain inflation. Yet another tightening of monetary policy in India, with the Reserve Bank lifting the repurchase rate by another 25bp yesterday morning to 7.5%, the 10th increase since the start of last year. Despite the Bank’s best endeavours, inflation has thus far continued to accelerate: last month, wholesale inflation jumped above 9% from 8.7% in the previous month, well above the explicit aim of 6%. India is not alone in fighting the inflation curse – central banks right around Asia have been hiking rates in an attempt to prevent prices growth from climbing. In a developing country such as India, rising food and energy prices very quickly translate in higher inflation, because both represent such a significant weight in the consumption basket.
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