Greece, China, UK Drivers

Currency in Crisis

Greek interest rates are rising from levels that officials have indicated were prohibitive. The country needs to finance about 12 bln euros next month. The weekend talks have been delayed to the middle of this week due to the disruption of air flights. The pressing issue that needs is preparing for joint (EU/IMF) program of conditionality for initiating the backstop facility. As of the end of last week, Greece planned on offering a 13-week T-bill tomorrow, but the yield appears sharply higher today.

It is thought that the IMF will likely demand additional cuts in Greece’s pension payments and other cuts in civil servant benefits. Up until now the Greek government has retained general public support, even through the large scale strikes and protests. However, the latest polls suggest the inclusion of the IMF may be the turning point as public support for additional cuts and savings appears to have reached their limit. While some resolution is possible around midweek—that the conditionality is aired and that the markets feel more comfortable that Greece will be able to make be able to roll over its bonds and service the debt coming due next month. However, this risk remains that this is too little too late. Market participants increasingly view this as a solvency issue not simply a liquidity issue.

Another key talking point in the foreign exchange market has been the speculation that a move on China’s currency is imminent. We have not been very sympathetic to numerous voices that have been saying this for weeks. On the contrary, we have suggested that many of those voices have mistakenly assumed the China, as a one-party state, speaks with a s single voice. It seems clear that the People’s Bank of China, the central bank, would like greater currency flexibility and even a strong yuan. However, there are other, powerful ministries in China, such as Commerce, that is not so keen. If one listens to the PBOC one could conclude, as many observers, including the New York Times, that a currency move is imminent. However, if one “triangulates” and listen to other official voices, one is struck by the uncertain global economic outlook and the reluctance to make any significant moves.

In contrast to the imagery from the fall of communism in Europe, the economic house was on fire and it had to be put out all at once—or to cross a chasm one cannot take two steps, Deng Xaioping said to cross a river step on the rocks. China’s modus operandi is to err on the side of caution. That said, China has stepped up its efforts to rein in the property market. Its latest moves include, barring loans for third homes, and suspending loans to non-residents (i.e. residents from other cities). These measures are the just the latest as officials gradually escalate their efforts. China has increased reserve requirements, raised mortgage rates and re-imposed a sales tax on homes. The Shanghai Composite, off a little more than 9% this year is among the worst performing equity markets this year.

We had identified three pre-condition to China moving on its currency: Rising inflation, increase exports and a more significant voice at the leading multilateral institutions. While these have been met, we also recognize that Chinese officials are proceeding with unwinding some of their stimulus and this is taking precedence over the currency.

While the US and EU continue to encourage China to move expeditiously on the currency, Korea, which hosts the G20, has suggested the yuan is unlikely to feature prominently at the upcoming meeting.

The unexpectedly strong showing by the Lib-Dems Clegg in last week’s first televised debate in the UK has prompted tightening of the opinion polls. Some polls suggest the Tories and Lib-Dems are at a virtual tie, with Labour slipping into a close third. Still the first-past-the-post and other electoral rules make it exceedingly difficult for the Lib-Dems to pull off a victory. In fact, there is some speculation that a change in such rules may be one of the conditions of the Lib-Dems supporting either party. The general thinking is that a hung parliament is bad for sterling because it of the uncertainty and weak mandate to enact strong measures. However, a minority opinion is that a coalition government will have a stronger mandate and any single party and there is strong political will for decisive action.