The US dollar is trimming its weekly loss against most of the major currencies, while extending its gains against the two currencies that it has appreciated against this week, namely the New Zealand dollar and the Norwegian krone. Both countries have cut rates in past fortnight and have signaled investors should expect an additional cut in rates.
The decline in US weekly initial jobless claims, and the stronger-than-expected Philly Fed and leading economic indicators offset the slightly softer-than-expected CPI report. The dollar began recovering yesterday and those gains have been extended today. Although the Fed funds and Eurodollar futures remain near the low yields reached in response to the FOMC meeting, we continue to believe the market is putting too much emphasis in the dot-plots, which Yellen herself has played down. Moreover, while two rate hikes this year, which the median dot-plot still points to, seems unlikely, we remain convinced there will be one rate hike and recognize that even that is no longer fully priced into the market.
That said, there seems to be one overriding focus today and it is Greece. Most observers have focused on Greek payments to the IMF and next month's more sizable obligation to the ECB. We have warned that the more pressing Achilles' Heel is the Greek banks. Now less than 48 hours after the ECB extended the ELA borrowing by 1.1 bln euros to 84.1 bln, the Bank of Greece has requested another 3 bln euros, which the ECB is considering.
The speculation about capital controls and Grexit has spurred an acceleration in the deposit flight. Greek banks have roughly 130 bln euros in deposits. Fitch estimates that as of mid-May, Greek banks had about 40 bln euros in assets that could be used as collateral, but it appears that conditions have worsened. Moreover, Greek banks have an estimated 59 bln euros of loans that are overdue. Many were restructured at the end of last year to "extend and pretend" so as not to take impairment costs. The tangible core capital in the top four Greek banks that account for 90% of the banking assets is estimated to be only 12 bln euros.
Official assistance for Greek banks is about 124 bln euros going into today's ECB ELA decision. It consists of the 84 bln ELA borrowing and about 40 bln euros from the ECB. The bottom line is that liquidity crisis is on the verge of becoming a solvency crisis. ECB's Coeure reportedly warned the Eurogroup meeting yesterday that it was not certain Greek banks could open on Monday. This seemed to be consistent with comments by Fitch's Longsdon who warned of the possible collapse of Greek banks.
In anticipation of more assistance, Greek bank shares are higher on the day and performing better than Greek stocks as a whole. Near midday in London, Greek shares are up 0.4%, with bank shares up twice as much.
Separately from the Greek banking crisis, the sovereign crisis remains unresolved. Expectations for the Eurogroup meeting were not as high as some in the media suggested. It seems clear that it cannot be resolved on the level of finance ministers. Although the issue involves finances, ultimately it is about politics. To this end, an emergency summit of the heads of state will be held Monday. This is in addition to the scheduled summit at the end of next week.
The euro has surrendered about half of this week's gain off Monday's low near $1.1190. It pushed up to $1.1440 yesterday and has slipped back towards $1.1300 today. A break of $1.1280 could spur a move toward $1.1200. Euro's heavier tone appears to be dragging sterling a bit lower as well. Sterling is still the best performing major currency this week, up just shy of 2%, with today's minor losses.
Besides Greece threatening to tear EMU asunder, and Italy's Renzi threatening Plan B over the refugee problem that would hurt the EU if there is no greater burden sharing, the rise of anti-austerity/anti-EU political parties is a force that investors are wrestling with. It is in this context that the Danish election results will be understood. The immediate market impact may be minor, but the implications are important. The opposition toppled the government in Denmark and the anti-immigrant/anti-EU People's Party drew a fifth of the votes, twice their support seen in 2011.
Former Prime Minister Ramussen will return to office, and it is not clear if the People's Party will be given a cabinet position. The outgoing Social Democrats are the single biggest party in parliament with 47 seats. They picked up 3. However, the center-right coalition holds 90 of the 179 seats. However, Ramussen's Liberal Party lost three seats, giving it 34. The People's Party won 37 seats, making it the second biggest party in the Danish parliament. This is a net gain of 15 seats for it. Whether it is formally part of the government or not, it can be expected to exert its influence.
Turning to Japan, the importance of the BOJ's meeting was not the substance of policy. It remains committed to expending its balance sheet at a rapid clip until the 2% inflation target is achieved. Instead, the significance was in the process. Specifically, the BOJ is cutting its policy meetings to eight a year, which is what the Fed does, and the ECB, which adopted new procedures, with the expansion of EMU to Lithuania this year, and part of the reforms Carney has instituted at the Bank of England.
In addition, the BOJ will update its outlook quarterly rather than every six months. This, coupled with more detailed individual BOJ member forecasts and risk assessments suggest a convergence with the operating style of the Federal Reserve.
After consolidating the dramatic move spurred by Kuroda's comments last week, the dollar first broke out to the upside, and when this failed to spur follow-through buying, reversed lower. However, it remains largely flat with the dollar around JPY123. We note that the 8-month uptrend in the Nikkei was violated yesterday, and despite today's nearly 1% rise, it was not able to move back above the trendline, which comes in near 20210 today. The lack of follow-through selling on the break, and the fact the Nikkei closed near its highs, warns of the risk that the trendline break may not be as significant as the chartists would say. The BOJ, pension funds, and corporates themselves continue to be seen props for the market.
Lastly, Chinese stocks closed broadly lower to cap the worst week since 2008. The Shanghai Composite lost 13.3% this week, with nearly half coming today (-6.4%). It leaves it up about 1.4% on the month still. Tighter liquidity and supply considerations seemed like the main culprits. Money market rates jumped the most in six months this week. IPOs are thought to have tied up CNY6.7 trillion (~$1.1 trillion), according to a Bloomberg survey. Separately, the BOJ did not roll over its MLA funding facility in the middle of the week. In addition, the quarter-end tax date is also thought to be draining liquidity.
Many have regarded the Chinese equity market to be experiencing a bubble, but the opinion is not universal. Still, the neck-breaking rally over the past year is seen as primarily driven by domestic investors not foreign. If anything, it appears that foreign investors have been net sellers. There does not appear to have been a significant knock-on effect from this week's sharp losses, but this will be very much on global investors' radar screens next week. The price action does play into ideas that part of the rally in recent weeks was in anticipation of the MSCI decision. It chose to wait before including the A-shares into its global indices pending further market opening and transparency reforms.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.