For much of yesterday global markets were in a particularly dark mood, amidst both heightened recovery concerns and fears over Greek debt contagion. We even had officials from both the US and China warning that Europe needed to get their act together because the loss of confidence in policy-making was adversely affecting the euro and threatening the global economy. By late afternoon the EUR had fallen to 1.4125, a decline of three big figures in just 24 hours. The dollar and Swiss franc as usual benefitted from the renewed avoidance of risk, while both Treasury and Bund yields declined. European equities closed around 2% lower, sovereign CDS reached new record highs for the likes of Greece and Portugal, and commodities were spanked. Most eye-catching was the oil price, with Brent crude collapsing $8 to a low of $106 at one point yesterday, now just under $109.
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In an attempt to stem the pervasive negativity, EU leaders cobbled together a statement at their summit meeting last night pledging their commitment to prevent a Greek default as long as the Parliament agrees to the package of budget cuts and asset sales. Separately, the troika released a statement endorsing the program of budget cuts they had negotiated with the Greek government. This show of love and commitment was reminiscent of last Friday’s kiss and cuddles between French President Sarkozy and German Chancellor Merkel. There is very little substance in terms of what has been announced overnight, but even so there has been some short-covering. The EUR is back at 1.4260 and the major Asian bourses are up to 2% higher.
Commentary
The search for volunteers. Reports yesterday suggested that talks were taking place between officials and the main creditors of Greece around Europe. Reports from Belgium suggested that creditors were asked to roll-over maturing sovereign bonds for five years at a coupon equivalent to averages of what the EU/IMF lending rate at, which is 1% below the initial 5.8% deal. Even if this was achieved across the board, the issue of Greek solvency will remain in place, but there would also be strong questions from bank investors and shareholders as to the efficacy of accepting such terms on their behalf.
Sterling gradually losing strength. With the UK private sector still firmly in recession, it really is no surprise to see the British pound under continuing pressure. Cable fell below 1.60 yesterday for the first time in three months, not helped by the dollar’s perky performance in response to a further bout of risk aversion. That said, sterling is losing out against other major currencies as well. For instance, at a time when the euro is under enormous strain as a result of the sovereign debt crisis, the pound is failing to make any headway whatsoever, with EUR/GBP at 0.89. Yesterday’s economic news reinforced the sense that the economy here in the UK is still suffering; the CBI measure of reported sales for June fell to -2 this month from +18 previously, the lowest reading for a year, and mortgage approvals remain very weak. Furthermore, the latest MPC Minutes suggested that some members would consider further QE should it be considered required, a concession which has certainly weighed on the currency. At a time of unprecedented austerity, the performance of the currency is closely matching the mood of the nation.
The Aussie is still battling. Amidst heightened risk aversion, the continuing resilience of the Aussie in the face of adversity is noteworthy. On another four occasions over the past week, the AUD has tested the bottom of the 1.05-1.10 trading band that has seen virtually all of the price action since early April, but each time the selling has been repelled. It remains a challenging time for the Aussie, with growing concerns over the weakening pace of the global recovery, worries that the local economy is also slowing down and a softening in commodity prices. For the Aussie optimists, the ability of the currency to continue to respect this trading band is encouraging. However, for the Aussie bears, it is just a matter of time before the dam breaks after such a constant bombardment. It remains an absorbing tussle.
Is Trichet seeing sense on rates? One of the major failings of pre-crisis central banking was an approach overly wedded to inflation targeting with scant regard for growing financial risks. This is why we now have the Financial Policy Committee in the UK and the European Systemic Risk Board (ESRB) in the EU, set up to engineer a more macro-prudential approach to policy-making and hopefully foreseeing some of the warning signs of a future crisis. According to Trichet (also head of the ESRB), these warnings signs are now flashing red and he acknowledged on Wednesday that the link between the sovereign debt crisis and the European banking sector “is the most serious threat to financial stability in the EU”. But should this impact on his outlook on rates? Yes, because the level of rates is only part of the policy mechanism in a credit crisis. We’ve already seen inter-bank lending rates tighten this month (3-mth Libor-OIS spread 7bp wider over the past week), as well as overnight rates moving above the ECB’s 1.25% re-financing rate. Whilst hard evidence on greater credit restrictions is more difficult to come by in the short-term, it is hard to believe banks are not responding to the very real threat of write-downs on Greek debt (voluntary or otherwise). As such, it would make no sense for Trichet to reinforce this tightening of financial conditions by also putting up the ECB rate by a further 25bp, as strongly suggested by his use of “strong vigilance” at this month’s post-meeting press conference. Furthermore, yesterday’s PMI data, coming in below expectations for the eurozone on the manufacturing and services measures adds further weight to the view that we are seeing a more synchronised global slowdown, with concurrent and related financial risks. We’ve seen both the Fed and also the BOE acknowledge these developments this week. For the ECB to ignore all of this and tighten policy regardless next month would be nothing short of disastrous for the eurozone.
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