The next best performer... RBNZ and the Haka interest rate cut!

The best performing currency last week was the euro – why? Didn’t you hear everything is resolved?! Sorry, we couldn’t resist, but the situation is actually far from it. The only reason the euro went up is because the Greek government managed to pass the legislation that the Eurozone demanded before any negotiations of a third bailout package. As a reward for doing what was dictated, Greece received a €7bn bridge loan. Unfortunately, the Greek government received very little of the loan as it was quickly directed towards repaying debts to the ECB and IMF.

The next best performer was the NZD. The Reserve Bank of New Zealand cut interest rates by 25bp last week for the second time in a row due to softening economic outlook and inflation. The RBNZ said that further easing seems likely and a further drop in the currency is necessary, which would normally be a negative for the currency. However, the NZD rallied hard because the RBNZ dropped the reference to the NZD being "over-valued" or "unjustifiably high" in its announcement. Meanwhile, the AUD was the worst performer last week as it fell to fresh multi-year lows due to the sharp slowdown in Chinese manufacturing activity. As for last week’s dual winners the USD and GBP, they took a break after their spectacular gains in the month of July to quietly correct and work off their overextended gains.

The peso has been trading in a negative territory since mid-July due to the rout in commodities. The domestic economy is growing at a slow pace however the jobless rate fell to 4.41% in June. Thus, there is another factor at play here. The peso happens to be one of the most liquid currencies in the sphere of emerging markets. Thus, if investors fear problems in EM they will sell the peso regardless of their view of the Mexican economy itself. That is what is currently happening as investors fear monetary tightening by the US Federal Reserve. The worry is that a rise in interest rates in the U.S. will cause the debt servicing to rise on the roughly $4.5 trillion dollars in EM loans. Complicating the matter is that most of the EM countries rely on commodity exports and/or Chinese growth, thus they are getting hit by a double whammy – decreasing export revenues and increasing debt servicing costs.

Having said this, according to Citi there is another factor at play in the peso’s weakness. Citi’s research shows that the foreign exchange flows handled by the bank on behalf of its clients flow into real money accounts, leveraged accounts, corporates, and banks. Its latest date shows that USDMXN transactions flows into the first three categories has been neutral over the year, but flows by banks has been strongly negative. So what does this mean? It means that the Mexican people themselves are responsible as they are converting their pesos into USD and depositing them in USD accounts at their banks. Hmmm, they must know something that the rest of us don’t.

The key events for this upcoming week are the FOMC rate decision and Q2 GDP report. While we are not looking for the Fed to raise interest rates in July, most economists expect the first interest rate hike in 8 years at the September FOMC meeting. Also, remember that Chair Yellen indicated at her semi-annual testimony on Capitol Hill that her preference was to start raising rates earlier so that monetary policy can be tightened at a more gradual pace going forward. All we can say about this is we wonder if she will be able to pull the trigger if China keeps slowing, world trade volume drops for a 7th month in a row, and oil fall below the March low of $42.

The US Fed Decision and Commodity Currencies

The currencies of commodity-exporting nations including Australia, New Zealand, Canada, Brazil and Indonesia are near the lowest in at least 4 years as the market braces for a Federal Reserve statement tomorrow that may indicate it is ready to raise interest rates – it’s not likely that the Fed will make actually make a move this week, but economists and analysts aren’t expecting anything more than indications that September is when we’ll see the first hike in rates in several years.

The market is hotly awaiting the post-meeting comments for hints of a rate increase and should that happen, then expect another surge in the USD and further downward pressure on currencies of the aforementioned nations. These nations are hoping that Fed Chairperson Janet Yellen will portray a cautious tone in her statement, which would pause a sell-off in AUD, NZD, CAD, BRL and IDR.
“Commodities are very much in the forefront of markets’ minds and commodity-linked currencies are definitely under pressure,” said Sam Tuck, a senior currency strategist at ANZ Bank New Zealand Ltd. in Auckland. “The majority in the market believes Yellen will remove patient” from the Fed’s pledge on interest-rate policy, he said.

New Zealand’s currency weakened last week after the whole milk price index fell almost 10% in a GlobalDairyTrade auction. The Aussie has been falling amid a decline in prices for iron ore and prospects for a further interest rate cut, with the Reserve Bank of Australia’s March 3 meeting minutes released yesterday reiterating an easing bias. And energy makes up the bulk of Canadian, Brazilian and Indonesian exports. Therefore, a sharp decline in energy, gold, dairy and metals combined with a mix of a strong dollar and a weakening Chinese economy plus looser monetary policy (except for Brazil where rates are still high) – what you get is a flood of commodity bears in full-force to claw down the value of commodity currencies.

Market strategist for IG feels that tomorrow's meeting has the possibility to be a boon for the disintegrating commodity sector. In a note from this past Monday morning, IG said that, "The Fed policy statement release may actually halt the USD bulls." The note further states that "Expectations are low for any major divergence from current language or action. The FOMC may even be a little more cautious about the current market and economic conditions. This would see a quick unwind in oversold markets: Oil and industrial metals would likely rise and a likely drop in the USD would transpire."

Puzzled?

Earlier this month we speculated that the Bank of Canada could cut interest rates after the negative April GDP print; and in last week’s blog post we said that we would be shocked if the BOC didn’t cut because of the string of negative data point after the disappointing April GDP report. Faced with a firestorm of recession talk, the BOC had no choice but to cut interest rates by 25bp to 0.5%. The CAD was promptly sold hard to six years lows. The price action far exceeded our expectations especially after the BOC raised the possibility of QE, if necessary, indicating that this move may not be the end of its easing campaign.

Bank of Canada Governor Stephen Poloz refrained from using the R word by stating that "real GDP is now projected to have contracted modestly in the first half of the year." The BOC also lowered its 2015 growth forecast from 1.9% to 1.1%. For 2016, it expects the economy to grow by 2.3% versus a previous forecast of 2.5%. The economy is not expected to return to full capacity until 2017. As for inflation, the underlying estimate is now 1.5% instead of 1.7%. As you might imagine, the decline in the price of crude oil was the major culprit in the adjusted forecasts.

In the press conference after the policy announcement, Governor Poloz said two things that really
stand out and didn’t seem to receive enough press. He mentioned that he was puzzled that the weaker CAD failed to improve non-energy exports. This statement struck a chord with us because two other countries have had that similar experience. The weak yen has not caused a surge in Japanese exports. Similarly, the weak euro has also not caused an increase in exports as evidenced in the recent Eurozone May trade figures which showed that exports fell 1.5%. We are not sure why this would be puzzling – after all, central banks are engaged in a currency war and no country can gain an advantage if all central banks are counter acting other bank’s moves with matching simulative monetary policy measures.

The other thing that Poloz said was that he expected the Canadian economy to be less in sync with that of the U.S. Are the economic cycles of the two nations that much out of sync? Many economists certainly think so – according to a recent survey in the Wall Street Journal, 82% of economists expect a Fed hike in September. If that is the case, the CAD is in for way more downside that anyone currently expects.

Still the One

With Greece and the Chinese stock market off the front pages, safe haven flows subsided and the monetary divergence theme reasserted itself as the driving force in the currency markets. Last week, the GBP was the top performer as positive economic data, including accelerating employment earnings, and a chorus of Bank of England members sounding more hawkish about a rate hike. This caused the timing of a UK rate hike to move from Q2 2016 to Q1. Having said this, the U.S. is still the one. No, we are not referring to the 70s soft rock ballad by Orleans but rather the only major central bank that is on course to raise interest rates in 2015. Federal Reserve Chairwomen Janet Yellen was on Capitol Hill last week and she stuck with her script by reaffirming that the central bank was on track to raise interest rates this year. If you remember, this is the very same driving force that prevailed in January of this year as the rate hikers were the top performers while the rest of the countries were moving in the opposite direction.

Apart from the central banks of the US and UK, the other major central banks have either a neutral bias or are in easing mode. The ECB left its policy unchanged at last week’s meeting and reaffirmed that the conditions of low inflation remain. Thus, its policy of bond purchase will remain in place. The Bank of Japan also had its meeting last week and it adjusted its inflation forecast – it no longer expects to hit its inflation target until after 2018 which means that it may need to apply more stimuli in meetings to come.

China reported a slew of key economic indicators last week, including Q2 GDP. It announced that its quarterly GDP came in right on target at 7%, like it always does. However, this time the chorus of investors responding with disbelief was louder than ever. No one believes their data anymore. Leaving this aside, China will probably need to administer more stimulus but more importantly their economy is not growing like it was, which is putting tremendous pressure on commodity prices and the economies of the countries that produce them – Australia, New Zealand, and Canada. Australia was the best performer of the countries in easing mode mainly because their next central bank meeting isn’t until the beginning of August. New Zealand was the worst performer because their next central bank meeting is next Wednesday; and after last week’s disastrous dairy auction, the odds have increased dramatically that the RBNZ will cut rates by 50 bps instead of 25 bps.

Tony Valente
Fred Maurer

Oximoron

Teetering Technical Recession

Canada may be teetering on the brink of a technical recession as business investment plunged in response to slumping crude-oil prices. Last Tuesday, Statistics Canada released the April GDP report and it showed that Canadian real GDP contracted for a fourth consecutive month, with real GDP down by 0.1% in the month. Market expectations were for a 0.1% increase in April. The data is raising concerns in the economy’s ability to post growth of 1.8% in the second quarter, which is what the Bank of Canada is expecting. This is raising speculation that the BOC could cut rates as soon as its next meeting on July 15th, which would weigh heavily on the CAD.

The BOC cut rates in January as an “insurance policy” for the economic fallout in the plunge in the price of crude oil. Crude oil was under pressure last week due to the increase in drilling rig counts and the possibility of a near term deal between Iran and the USA which would put more supply into the market. As you can see from the chart, the price of oil has stabilized over the last couple of months but it is in danger of slipping below its lowest level since mid-April. If it breaches that level the next support would be around the $52 level. The BOC will be watching the chart below very closely and may be tempted to take out another insurance policy by way of a rate cut.

The CAD fell through the green trend line on the daily chart on the negative GDP news of last week. The downside stalled near the mid-April low around the 0.79 level. However, increase speculation on another BOC rate cut and continued pressure on crude could put the mid-May low of 0.7780 in play. There is plenty of Canadian data this week - Ivey Purchasing Managers index, Business Outlook Survey, Building Permits, Housing Starts, and Friday’s employment data.

The Japanese yen finished at the top of the leader board last week as the yen did what it always does in a risk off environment – it races to the top as it benefits from safe haven flows. Interestingly, the commodity currencies of Australia, Canada, and New Zealand were the worst performers, and they all under-performed for the same reasons – risk off, lower prices of key commodities, and potential monetary policy moves. Greece and the Chinese stock market selloff have pushed safe haven flows to the yen and USD. The AUD was weighed down by declines in the price of copper and iron ore; the CAD suffered due to the down draft in the price of crude oil; and the NZD continued to suffer from the ongoing decline in milk as the GlobalDairy Trade index declined for the eighth consecutive week. The commodity price and economic backdrop for all three of these countries is putting pressure on their respective central bank to make some near term policy moves.


Over the weekend China demonstrated that it is very nervous about the 30% decline in its stock market since June 12. The week before the Chinese central bank lowered its key one-year lending and deposit rates and cut reserve requirements. These moves failed to arrest the fall in the stock market so on Friday more measures were announced by various group – 25 mutual funds companies stated that they would actively buy stocks and hold them for at least a year, 21 brokerage firms said they would invest 15% of their net assets (about $20 bln) in the ETFs of high capitalization stocks, and finally no new IPOs were being issued for the time being. These moves reek of desperation. The other big news over the weekend is that Greece voted “no” in their referendum. What this means precisely is unknown and it will probably play out over the following week, but we’ll go into further detail below.

Greece: The Unknown Abyss

In a previous blog post "More Cowbell?", we talked about possibly scenarios that might play out with a “no” vote. Well, we’re here, and frankly speaking, absolutely nobody knows what’s going to happen in the near- and long-term. However, everyone does agree that something must happen very quickly. Allianz’s Mohamed El-Erian offered a brief preview of what will happen next as a function of three main things:

 Whether Greece and its creditors can work together to reconcile what were two very different interpretations in the run-up to today as to what a “no” outcome means, and do so very quickly and effectively;

 Whether already horrid conditions on the ground, including the high likelihood of further delays in re-opening the banks and significant difficulties getting fresh money into ATMs, provide enough time for the politicians to get their act together; and

 Whether the ECB rolls out new measures to contain contagion.

The fallout from the “no” vote has already begun as the embattled Greek Finance Minister, Yanis Varoufakis resigned. In a blog post, Varoufakis stated, “"I was made aware of a certain preference by some Eurogroup participants, and assorted 'partners', for my ... 'absence' from its meetings; an idea that the Prime Minister judged to be potentially helpful to him in reaching an agreement. For this reason, I am leaving the Ministry of Finance today." He continued, "I shall wear the creditors' loathing with pride."

Speaking of creditors, no discussion on Greek debt is complete without identifying who is owed. Currently, Greece’s public debt stands at €323 billion, which is nearly 175% of the country’s GDP. You don’t need us to tell you that this is completely unsustainable.

There are simply too many unknowns to get into a deep analysis of what might happen in the coming days and months. As we said earlier, the process must start very quickly and openly so that the markets find some stability. In addition, the last thing we want to do is misguide you as you make decisions on your personal or corporate exposure to FX, particularly the EUR. That said, we love an informed customer, so please call us at 604-685-1016, or email us at info@vbce.ca. We would be more than happy to give you up-to-the-minute information on what’s going on in the markets.

The FX Roundup

We did not see this coming. I’m not referring to the “ohi” (otherwise known as “no”) vote delivered by the Greek people (for you students of Modern Greek “ohi” is pronounced “o-hee” with a guttural “hee”). I am referring to the mandate delivered; a clear margin of victory for those rejecting the proposed austerity measures. While the market waxes and wanes some minor details need to be worked out, such as “Is the referendum binding?”, and “If so, how?” Maybe this whole matter needs to be kicked upstairs. As Axel Schaefer, a deputy head of the Social Democrats in Germany suggested: “EU leaders must get together immediately, even on Monday. The situation is too serious to leave to finance ministers”. This quote is so funny on so many levels we don’t even know where to start. We will say that we're calmed by the fact that it appears that someone important in Europe will be taking a look at this problem in the next 24 hours.


We will be bombarded with lots of news and commentary from all corners of Europe over the next few days so we think it’s better to keep our own powder dry with respect to addressing where we go from here. Greek Prime Minister Alexis Tsipras tweeted out “Today's referendum doesn't have winners or losers. It is a great victory, in and of itself…. The mandate you've given me does not call for a break with Europe, but rather gives me greater negotiating strength.” We will see about that in 6 months if after rejecting the bailout terms Greece teeters on the brink of total collapse before capitulating to something far more draconian than the deal on the table today.

Ο ανήφορος φέρνει κατήφορο

With his back to the wall, the Prime Minister of Greece, Alexis Tsipras, did what every politician in his position would do – he made a political move by calling for a snap referendum to be held on July 5. The question to be put before voters is whether or not the country is willing to submit to the conditions being demanded by the International Monetary Fund, European Union and European Central Bank. This may be a moot point because the IMF is owed a payment on June 30th; this will not be made and opposition leaders may call for a no-confidence vote. If successful, it would cause a new government to be formed or the dissolution of the government and new elections. As you can see there are still many unknowns at play here.

What we do know is that the Greek banks have no more money, so a bank holiday and capital controls was implemented yesterday (Monday, June 29th). For the rest of the Eurozone, we are sure that the key leaders of each country will have that Boomtown Rats song playing in the back of their heads – “I Don’t Like Mondays.” We can see headline already – “Black Monday”, “Lehman Weekend”, “Opa Oops”. As we write this commentary, trading has opened and the Euro has gapped down.

Lest we forgot, the other big news was that on Friday out of China. China’s central bank cut reserve requirements up to 50 bps and cut the benchmark one-year deposit and lending rates by 25 bps. Strap on your seat belts because this is going to be humdinger of a week!
What are the Capital Controls in Greece?

During the summer months, Greece isn’t typically known for high-stakes drama, but in the last few days, negotiations between Greece and its European paymasters indicate that the country’s economic crisis is approaching a breaking point. Briefly summing up the banking crisis, deposits fell to an 11-year low in May and have lost nearly 15% of their value since November. Stoking the flames is the fact that wealthy Greeks pulled their money out of Greek banks as soon as the Leftist Syriza government came to power in January with the promise to end austerity. With tomorrow’s bail-out expiry looming, more and more ordinary citizens have started queueing up at ATM’s to pull out their savings in fear of a full-blown banking collapse.
The Greek government implemented a number of measures in the early hours of Monday to keep money in the financial system. Here is a summary of the capital controls that were implemented to protect the financial system:

 From Monday, June 29, 2015, banks will remain closed up to and including Monday, July 6;

 Deposits are fully safeguarded;

 The payment of pensions is exempted from the restrictions on banking transactions. Management of credit institutions will announce how these will be paid;

 Electronic transactions within the country won’t be affected. All transactions with credit or debit cards and other electronic forms (web banking, phone banking) can be conducted as normal;

 Prepaid cards may be used to the limit existing before the beginning of the bank holiday;

 From midday June 29, ATMs will operate with a daily cash withdrawal limit of 60 euros per card, which is equivalent to 1,800 euros a month;

 Foreign tourists can make cash withdrawals from ATMs with their cards without restrictions provided these have been issued abroad; and

 A special Committee to Approve Bank Transactions has been established at the State General Accounting Office in cooperation with the Finance Ministry, the Bank of Greece, the Union of Greek Banks and the Capital Markets Commission. This committee will deal with applications for urgent and imperative payments that can’t be satisfied through the cash withdrawal limits or by electronic transactions (e.g. payments abroad for health reasons). Wages paid electronically to bank accounts aren’t affected.

The question becomes, will the capital controls affect the outcome of the referendum? It’s hard to dissect the psyche of the average Greek citizen at the moment. Waking up in the morning to find out that you can only take out 60 Euros per day will certainly have a big impact. But if the Greeks think that the Europeans are cutting them off, it could push them to vote “No” and reject the bail-out deal. On the flipside, the prospect of life under capital controls could scare many into voting “Yes” out of fear of things to come should they leave the Euro.
Hold on to your hats – HUGE week ahead!

Oh yes, before we sign off, you may be wondering about the title of this piece, Ο ανήφορος φέρνει κατήφορο, which in Greek means the uphill is followed by a downhill. It’s the equivalent of what goes up, must come down.

More Cowbell?

Surprisingly, the biggest story of the week wasn’t Greece but the USD and the Fed. Federal Reserve Chairwoman Janet Yellen emerged from a two day policy meeting to declare that the FED NEEDS “MORE DECISIVE EVIDENCE”. More cowbell? Are you kidding?! It seems that every time the market’s perception gets closer to thinking the Fed is about ready to finally raise interest rates the Fed pulls the rug out from underneath that train of thought. After more than 6 years of emergency monetary policy, which included QE1, QE2, QElite, QE3 – all under a zero interest rate policy – what is it that the Fed is fearing?

The USD took it on the chin (more on this later) as it appears the market has lost complete faith in the Fed. For example, let’s take a look at the Fed’s revised growth rate for 2015. It downgraded 2015 GDP to 1.8-2.0% from 2.3-2.7%, which had already been downgraded in March. Doing the math, Q1 came in at 0.7% and the Atlanta Fed GDP Now model has Q2 at 1.9%. Thus, to get to 2.7% for the year means that both Q3 and Q4 must come in at 4%. This may be a tall order, but if it happens then we should expect the Fed to raise interest rates.

Now for the USD, the reaction after the Fed announcement was swift and fast. The US dollar index is not on firm ground on the charts. The 50-day moving average has crossed the 100-day moving average, which is known as a death cross in technical analysis. As you can guess from the name this is not a positive development, as it indicates a bear market is on the horizon. The momentum indicators are also flagging.

On the fundamental side, the America’s trading partners are heading in the opposite direction. Japan has signaled that it no longer wants a weaker yen. The UK looks to have regained its legs after the Scottish referendum, the federal election, and a central bank that appears comfortable in raising interest rates in mid-2016. Europe looks like it has escaped deflation and is slowly on track for positive growth despite its problems with Greece. As for China, it is starting to exhibit some green shoots – just last week China’s business indicator reached its highest reading in a year at 53.5 from the 49.7 it registered in May.

Salvation to Catastrophe: What might happen to Greece

We found this excellent article on Bloomberg, which we thought is worth a read. You can find the Original article here

The Greek saga has haunted policy makers for more than five years. Now talks are deadlocked, banks are on life support and time is running out. With financial doomsday drawing ever closer in Athens, everyone from creditors and investors to depositors is increasingly focusing on what's next.
Some things are clear:

 Greece owes the International Monetary Fund about $1.7 billion this month.

 In July and August, the European Central Bank is due almost 6.8 billion euros ($7.6 billion).

 The euro-area backed bailout program expires on June 30, with creditors refusing to release up to 7.2 billion euros in remaining funds before Athens complies with belt-tightening conditions.

With time running out to close a deal, the German government has begun planning for a Greek default, according to Bild newspaper. If you're waiting for a clear resolution to the country's status in the 19-nation monetary union, you may wait a long time. Adopting the euro was always supposed to be a one-way ticket, so there is no legal precedent or political roadmap for an exit.
Next steps for Greece range from retaining the euro to catastrophic divorce. Half-measures are also on the cards, such as having multiple currencies circulate, with aid recycled to repay foreign-currency debts. Equally unclear is who would tell the world - and how - that Greece has entered an economic afterlife. Possible messengers include Greek Prime Minister Alexis Tsipras, European Central Bank President Mario Draghi, European Union President Donald Tusk and European Commission President Jean-Claude Juncker. There could be others.
We asked economists, investors and former policy makers what could happen next – and how it might unfold.

Scenario A – Grexit Avoided

Tsipras, whose Syriza party won January elections promising to undo the tough terms of the bailout loans, capitulates to creditor demands. Faced with a choice between effective expulsion from the euro area or implementing austerity in exchange for loans, Tsipras takes the cash. The ECB maintains its support of the financial system.
While aid flows, the government's days are numbered as its most hardline supporters mutiny. A new coalition is formed with backing from the pro-European opposition and Syriza's moderate flank – or elections are called. Greece's continued euro membership is ultimately secured as new loans are used to repay the ECB and the IMF and the country's coffers are replenished. Greece gets easier repayment terms on bailout loans. This helps tame the popular backlash against the new wave of fiscal measures. However, the cuts attached to the agreement suppress economic output, delaying Greece's recovery from the longest recession on record.

Scenario B – Hotel California

Greek Finance Minister Yanis Varoufakis has described euro membership by using a lyric from the famous 1976 Eagles song: “You can check out any time you like, but you can never leave.” Tsipras might fail to strike a compromise acceptable to the German government, Communist factions of his Syriza party, and stakeholders in between. Somehow, though, he manages to keep Greece officially in the euro.
Bailout loans – Greece's only source of funding – remain stalled. With Europe's political leaders unwilling to proceed, the ECB rations Emergency Liquidity Assistance, the lifeline keeping Greek banks afloat.
That requires the imposition of capital controls – as there isn't enough cash to meet demand – following a bank holiday. We're calling the two possible outcomes from here “somersault” and “check out.”
Scenario B1 – Somersault
Capital controls mean that limits are placed on withdrawals and transfers. The dramatic consequences force Tsipras to compromise. Opinion polls show that most Greeks – between two-thirds and three-quarters of the population – want to stay in the euro area “at any cost”. “You can check out any time you like, but you can never leave.”
Tsipras forges a new coalition with opposition lawmakers of pro-European parties. A referendum carried out amid capital controls and with banks shut, gives him a mandate to reverse course. A unity government is formed and Greece remains in the euro, but not before the disruption triggers a new recession.

Scenario B2 – Checking Out

With banks shut, the political situation deteriorates and a popular uprising intensifies, with Germany targeted as the country's main antagonist. Polls show a swing in favor of breaking from the euro area.
Capital controls give the government the space and time to print either a new currency or IOUs for domestic payments. The new scrip quickly plunges, reflecting the weak fundamentals of an economy that has shrunk by about a quarter since 2008.

Euro-area governments give Greece a “sweetener,” a parting-loan in hard currency. The rationale is to avert total economic collapse, which would create a failed state in a strategically critical region.
Greece’s debt to public entities is restructured, providing for the repayment of loans to the IMF, either through the euro area’s crisis fund or from the departure credit. Greece remains shut out of debt markets. Most Greek companies and banks default. Some bank deposits are seized to recapitalize a shattered financial system, or redenominated to the new legal tender equivalent. The sovereign debt
restructuring of 2012 has already ensured that the state won’t have to pay principal on most of itsexisting loans to private investors and the euro area for the next few years and until the economy stabilizes. Both the new paper and euros circulate. Greece may not officially leave the euro zone – the door is open to a return in good standing – though the country sputters in a financial purgatory.

Scenario C – ‘C’ for Catastrophe

Greece separates from the euro area in a messy default, amid demonstrations and deepening misery for most, with the government blaming everything on the Germans. No help is provided to support a new currency and to keep servicing bonds and IMF debt. That triggers cross-default clauses to all creditors. The government and banks collapse, meaning that years will be needed before a new structure emerges. Greece's economy plunges into a second depression. The blow from the biggest default in the history of capitalism drives Europe back into a recession and heaps pressure on vulnerable euro countries such as Italy.

Bad blood leads to Greece’s departure from the European Union. The idea that the euro is irreversible is thrown into question, rattling global markets. The economic implosion paves the way for extremists, from either the left or the far right, to take power. Those who can, flee the country. The tumult casts doubt on Greek membership in NATO. A new – and unstable – government turns to Russia for support, providing a Mediterranean outpost for Vladimir Putin.

Mixed Signals

 

 

The USD ceded some ground to the other majors this week, in spite of a late rally. As you can see from the one day relative performance table, investors were caught leaning the wrong way ahead of the week’s main data release, Friday’s non-farm January payrolls report on the US labour market. The report smashed expectations as the economy added 257K jobs, far above the 230K that was expected. In addition, the November and December reports were revised up by 147K making it the strongest three months of jobs gains in 17 years. Not to be outshined, average hourly earnings surged from last month's disappointing -0.2% to a whopping 0.5%, which was the highest monthly jump in average hourly earnings since November 2008. However, on an annual basis the increase was a less impressive 2.2%. Nevertheless, these reports restored a large amount of faith in the US economic recovery. Sentiment had been firmly against the USD since the beginning of January as U.S. economic reports were sending mixed signals about the strength of the economy and the timing of the Fed’s first interest rate hike. Doubts about the Fed’s timing arose after disappointing December average hourly earnings and retail sales. Other reports adding to the discourse was the falling employment component in both the ISM Manufacturing report and the ISM Non-Manufacturing report and the 17.6% rise in layoff announcements in the Challenger Grey & Christmas reports.

 

Friday’s very strong labour market reports have put a June rate hike by the Fed back into the picture. This will allow the Fed to drop or dilute it reference about “patience” at its March meeting, which would lay the groundwork for an interest rate hike at its next meeting in June, which incidentally also includes a press conference. On the other hand, the Fed can certainly afford to remain patient before raising interest rates, given the global deflationary backdrop, the downward pull on inflation from low oil prices and the strong USD. But before we get to the next FOMC meeting on March 18th, the USD may come under pressure ahead of the release of the January FOMC minutes on February 19th and U.S. Federal Reserve Chair Janet Yellen’s semi-annual congressional testimony on monetary policy on February 24th.

 

Before we end this Dispatch, we would like to make two short points about the euro and CAD. The euro has been going back and forth within a 2 cent range on headlines about Greece and its solvency. One of our favorite sound bites this week came in an exchange with European Parliament President Martin Schulz and Greek finance minister Yanis Varoufakis. Schulz warned that Greece risks national bankruptcy if it continues down the path of non-agreement. Varoufakis’ response was to simply restate what he had previously said that Greece is already bankrupt. What you need to understand is that this is just plain old posturing and that the real negotiation will occur in the 11th hour. Greece needs about 10bln euros by the end of the month, but even this deadline may extend for another few months. Positive headlines will cause a short squeeze in the euro while negative headlines will cause the euro to sell off.