In this week’s macroeconomic and market update we focus on the latest developments in the ongoing Grexit saga, growing problems for the Chinese stockmarket and George Osborne’s Summer Budget. Read on for more details.
Chinese equity markets continue to deteriorate
Whilst most people have been watching events unfold in Eastern Europe we are becoming increasingly concerned by developments in the Far East, as authorities in China resort to ever-more desperate measures to control an equity market that looked to be in a complete rout. Although on the surface these interventions appear to have brought a temporary respite, the extremity of measures deployed so far could have serious repercussions given the reputational damage that is likely to have been done to the authorities.
Given that we can scarcely consider Chinese equities to be under even pseudo-free market conditions, there is now a lot of uncertainty as to what the actual true state of the Chinese market is. More than half of the equities in Shenzhen and Shanghai have been suspended (at the request of the companies themselves) and there are suggestions that this could be related to bank loans secured against these companies’ own equity. Authorities have also intervened to relax margin requirements, and have even provided directing funding to support margin lending activity – effectively investing in the stock market through borrowing.
This is a particular worry as it could provide a more direct mechanism for further economic damage, as equity market falls manifest through debt instruments into potential defaults within the broad banking system (on top of any wealth effects). The command apparatus in China has managed to engineer an arrest to the most recent falls (and recall that in addition to the above, they have also ordered major shareholders not to sell stocks and instructed traders not to short the market). However, it remains to be seen how long this will last and how much further the authorities are prepared to intervene.
In our view this poses a bigger risk than Greece – both through market-related sentiment channels and through the pressure on a Chinese banking system which has been misallocating capital for a number of years.
Has Greece turned the corner?
The situation continues to develop in Greece, with initial reports of another deal being reached as markets opened on Monday morning. Banks are still closed and at some point they are likely to run out of cash – possibly in the next few days. However, the announcement of a deal may be enough to allow the ECB to maintain funding support for the Greek banking system in the interim, although a question mark remains over how a €3.5 billion payment due to the ECB on Monday will be dealt with.
The Greek Government appeared to blink first while under extreme pressure last week. They presented a reform plan that capitulated to many of the creditor demands in the last round of negotiations, and effectively acted against the outcome of the recent referendum. Interestingly this caused a split between Eurozone leaders, with the French leading a faction that wanted to accept the latest terms and bring Greece back into the fold, while a German-led group had further demands and questioned whether the Greek Government was willing or able to deliver on the current proposal.
Negotiations over the weekend were tense and reportedly had to be suspended on Saturday night after German finance minister Wolfgang Shäuble “lashed out” at European Central Bank president Mario Draghi.* Details of the current deal are still emerging, but it is likely to total €86-87 billion including around €25 billion to recapitalise the banks. In addition to proposals submitted by Greece last week, the deal includes reforms to the labour and product markets and a ‘Guarantee Fund’ of around €50 billion of Greek assets (based in Greece). However, debt relief has been ruled out at this stage.
From here, initial approval is needed from the Greek government by Wednesday followed by ratification in other Eurozone nations by Friday. This then paves the way for financing via the official European Stability Mechanism programme. The initial market reaction has been positive, but we have been in a similar situation several times before so it seems prudent not to count the chickens until the eggs have hatched.
Last week’s other events
- Chancellor of the Exchequer George Osborne delivered the Summer Budget last week. This effectively replaced March’s Budget made under the previous coalition with an all-Conservative equivalent. Further welfare cuts were announced as well as a cut in corporation tax. The deficit reduction plan remains largely on course, though the timeframe has been slightly relaxed to achieve a budget surplus one year later than previously envisaged. See our full Summer Budget commentary.
- UK manufacturing production disappointed with a further month-on-month slip that saw annual growth increase to 1.0% compared to forecasts of 1.8%. Construction output also slowed to 1.3% from 1.8% previously, despite forecasts of 3%. However, broad industrial production surprised on the upside by accelerating to 2.1% year-on-year growth from 1.2% before and 1.6% expected.
- Over in the Far East, Chinese headline inflation readings increased from 1.2% to 1.4% in June. On the other hand factory gate prices fell further than expected, down 4.8% from a 4.6% fall in May.
- Global growth was downgraded by the IMF. Global GDP growth for 2015 is now expected to increase 3.3%, rather than the 3.5% estimated in April and behind 2014’s growth of 3.4%. The Organisation for Economic Cooperation and Development also saw its leading economic activity indicator flatline, coming in at 100.0.
Last week we saw the markets react to the ongoing crisis in Greece, further deterioration of Chinese equity markets and George Osborne’s Summer Budget. But which asset classes were better off and which took a fall?
Equities – There was a clear divide between European and Asian markets during the week. Seemingly buoyed by the fresh possibility of a Eurozone deal, European equities rebounded at the end of the week with the FTSE Europe (ex-UK) closing up 2.8% and the FTSE All-Share finishing the week up 0.9%. Conversely, in the Far East the Hang Seng closed the week down 4.4% despite a rally in the last couple of days, and Japan returned -3.6% as measured by the Topix. The US, straddling the two regions, was flat overall.
Bonds – Gilt yields widened in the UK, with ten-year’s finishing the week 10 bps wider at 2.09% in a week where the Chancellor announced a less stringent deficit reduction plan in the emergency Summer Budget. Elsewhere moves were fairly muted – German bund yields widened by 5 bps to 0.90% and US treasuries steepened somewhat. In Japan yields tightened across the board, with 10-year JGBs 6 bps tighter to 0.45%.
Commodities – Oil remained below the US$60 mark with Brent Crude closing at US$58.02 per barrel. Copper remained weak to finish the week at US$2.55, and gold was similarly uninspiring by closing Friday night at $1,157.70.
Currencies – The euro was the main mover over the week, strengthening against major currencies and finishing up 1.2% against the dollar at US$1.1124. The pound was also marginally weaker after the Summer Budget, down 0.28% versus the dollar to £1.5504.
The week ahead
We have a busy week ahead – both in politics and in numbers. After a quiet start on Monday, a host of leading and lagging indicators are released across jurisdictions with peak activity Tuesday and Wednesday.
On Tuesday we can look forward to UK inflation figures, US retail sales figures and EU Industrial Production numbers for May – which we expect to have accelerated to 1.9% from 0.8% in April. These are followed on Wednesday by a host of data from China, including Q2 GDP growth which is expected to have slowed from 7.0% to 6.9%. Midweek will also see the release of UK employment data which is predicted to show an increase in average earnings from 2.7% to 3.3%.
Away from the numbers, the Fed will publish its latest Beige Book on the economic outlook on Thursday. Chairwoman Yellen is due to give testimony before Congress afterwards, and similarly the ECB will hold a press conference after its policy meeting on the same day. On both sides of the Atlantic the markets will be dissecting every word.
On Friday morning we have Eurozone Construction Output followed by US inflation and housing data. Expectations point to fewer new building permits but more new housing starts with annual inflation picking up slightly. We finish the week with preliminary data for the Michigan Consumer Sentiment Index.
* FT.com, “Greece’s eurozone future uncertain as Germany steps up pressure”http://www.ft.com/cms/s/0/8681a02a-287d-11e5-8613-e7aedbb7bdb7.html#slide0, accessed 23:03 12/7/15.