The G8 Summit achieved very little in public which was no real surprise, but there was also an apparent lack of urgency surrounding the euro-zone situation which was a much greater surprise given a sharp deterioration in the financial sector last week. Where was the urgency for fresh action to help support the euro banking sector? The absence must surely indicate that euro-zone and G8 leaders, while paying lip-service to the current strategy, have effectively moved on and are actively planning the next stage of the crisis.
Fear is likely to dominate in the short term and this is likely to keep strong defensive demand for the dollar and yen. In these circumstances, there is no real chance of a sustained euro rally with 2012 lows likely to be seen. Bond markets will be watched very closely and any further decline in yields for Germany and the US would indicate that fear is continuing to dominate. There is a case for buying the euro on hopes that a Greek exit will trigger a quantum leap in firewall support and generate at least a temporary euro rally, but this still looks too early.
The only hope for keeping Greece within the euro-zone is to panic the population into treating the forthcoming election as a euro referendum and hoping that scare tactics will be enough for the electorate to reject the siren voices of the anti-bailout parties and vote for continued austerity. The chances of success look extremely low given that Greece has already moved well beyond the point of no return, but the only other option is to capitulate on Greece ahead of the vote and completely re-write the loan deal. Such a capitulation would, however, also kill the chances of maintaining austerity packages in Spain and Italy and the whole euro-zone strategy as it stands would collapse.
There is of course a very important risk that markets will not be prepared to wait for the Greek elections. There is nothing more dangerous and terminal than a run on the banks and the euro area moved perilously close to this nightmare scenario last week. Four weeks is an eternity in the markets and there is a high risk that they will be forced to contemplate a Greek exit before the elections. In reality, euro-zone leaders must surely be making urgent and aggressive contingency plans for a Greek euro exit and hoping that the contagion effect can be contained.
The US economic data releases are unlikely to have a major impact during the week, especially with attention focussed firmly on the euro-zone data. Thursday's durable goods orders data will be important to watch, especially after the much weaker than expected report last month. The US economy badly needs strong investment to support any forward momentum and weakness last time around was particularly disappointing even though it was affected by a sharp decline in the erratic aircraft orders component. A recovery this month would sustain hopes of US out-performance.
Principal attention as far as the UK economy is concerned will be Wednesday's Bank of England minutes. No policy change was announced in May, but the markets will want a signal on future policy. Previous arch-dove Posen has already admitted that it might have been premature to stop calling for additional quantitative easing. The most likely situation is that he changed his mind after the May meeting as the euro-zone threatened to implode, but it might have been before hand. The bank commentary will be extremely important in assessing whether further quantitative easing is likely in June. Comments on sterling will also be important to assess whether there will be protests against any further gains.
The latest inflation figures on Tuesday will hold some interest and the latest litany of bank of England excuses on why inflation is above target will create sterling volatility. Demand conditions will dominate and if the UK economy threatens to be destabilised even further by the euro-zone then the bank will cut rates regardless of the inflation rate. Overall, sterling appears to have reached the limit of support on safe-haven grounds.
The Bank of Japan will be under further pressure to relax policy at Wednesday's interest rate meeting. China's economy will inevitably have an important impact on risk appetite during the week. Recent official releases have uniformly posted a more optimistic picture than real economic data such as electricity consumption and the official PMI index has also been consistently stronger than the HSBC version. Renewed deterioration in the HSBC index this week would further undermine confidence in the Chinese outlook and undermine risk appetite with the Australian dollar again the main victim.