Greek and Chinese Forces Drive Markets on Monday

The US dollar is firmer against most of the European currencies but is weaker within the dollar-bloc and many emerging market currencies.   Against the yen, the greenback is little changed.  

The US dollar has been pushed a more than a cent off the $1.0850 level approached before the weekend.   Sterling's push toward $1.5050 is a distant memory as it retreats to $1.4900 support.  

China's 100 bp cut in required reserves failed to fully offset the other measures announced, including the crackdown on margin, allowing fund managers lend shares and increasing the equities that can be shorted.   This follows the launch of two new equity indices that offer opportunities for portfolio insurance.  China's equity markets were off 1.65-2.0% today.  The Hong Kong Enterprise Index that tracks Chinese companies that trade in HK was off by nearly 3%, less than what some had feared before the weekend. 

The financial market moves are savvy.  With the Shanghai Composite up 79% over the past six months (Shenzhen Composite up 56%) and valuation metrics stretched, Chinese officials are right to develop such tools.  Time is of the essence.   

The cut in reserve requirements is a different story.  It is about the deterioration in economic conditions understood to include the capital outflows China is experiencing.  The move is estimated to free up a trillion yuan of liquidity, but given the outflow, this is being understood as reactive.  Chinese officials have also indicated they are exploring a long-term loan facility to banks.   Details are sketchy but it seems more like the ECB's TLTROs than LTROs.  The idea is to boost lending in specific areas,  such as agriculture, affordable housing and small businesses.  A key take away point is that Chinese officials seem committed to taking more measures to ensure the economy is not decelerating too quickly. 

We note that the dollar-bloc currencies are faring better than the Europe.  The Chinese stimulus, firmer oil prices, and constructive pric action last week helped blunt the impact of softer New Zealand inflation ( -0.3% in Q1 and 0.1% year-over-year down from 0.8% in Q4 14) and concerns about Australia’s CPI report on April 21.  The pendulum has swung away from an RBA rate cut next month, but sentiment is fickle.  Tomorrow’s release of the RBA minutes and Wed’s CPI report will likely impact expectations.   The Aussie could not extend last week’s gains that saw it poke just above $0.7840.  The US dollar is consolidating inside its wide pres-weekend trading range against the Canadian dollar.  

European shares are doing better than Asia.  Nearly all the bourses are higher, with the Dow Jones Stoxx 600 advancing more than 0.5% near midday in London.  Even the Greek stock market is participating, up around 1.5%.  The debt market is a different story.  Greek bonds are extending their decline.  The contagion that seemed to be rising at the end of last week appears  to have eased.  Other peripheral bond yields are3-4 bp  lower,  and premiums over Germany are also lower. 

Finland's national election results are unlikely to help Greece.   The outcome produced a fragmented parliament.  The winning Center Party took 49 seats in the 200-seat chamber.   The second largest parliamentary party with be The Finns, the euro skeptic party (38 seats).  The outgoing National Coalition will have 37 seats, and the Social Democrats will have 34.  In or out of the next government, The Finns will likely seek to harden the stance against additional rescue packages, especially for Greece.  Ironically, all the major political groups have endorsed domestic austerity, offing some combination of spending cuts and pro-growth measures,  Even though the economy has contracted for three years, the political elite continue to insist on drinking deeply from the ordo-liberal cup.  

Greece is expected to submit an updated and fleshed out the list of reforms.  However, it seems that regardless of what is submitted, it will not be sufficient to open up the creditors' purse so that Greece can service its debt at the end of the week's Eurogroup meeting.   At the same time, there are press reports suggesting that a pipeline deal with Russia could net the country a 5 bln euro advance.  Essentially, the deal would be a Greek leg of the Turkish Steam that would is part of the bigger effort to bypass Ukraine and service southern Europe.  It is not clear when such funds would be available to Greece, and it seems that it would be in both Greek and Russian interest to exaggerate.  

There are two main points.  EMU is irrevocable.  Greek debt is not sustainable on economic or political grounds.  The vexing issue is how to reconcile these two points.   There seems to be only one solution: some sort of debt restructuring within EMU.     US states and cities have defaulted in the past.  No one talked about pushing Detroit out of the union when it recently had to restructure its debt.  It is not because the US has fiscal transfers, and EMU doesn't.   It is mostly about attitude.