News that ongoing talks amongst politicians in Greece have failed to come up with a coalition government and that new elections will need to be called, has triggered renewed fears that a Greek exit from the eurozone might not be too far away. In response, risk assets are again on the defensive with both traders and investors seeking sanctuary in the US dollar. Overnight, the dollar index stopped just short of its highest level for the year, reaching 81.45. The euro was singled out for especially harsh treatment, falling to 1.27; EUR/GBP dropped to 0.7960, a 3½ year low. Bond yields amongst Europe’s southern fiscal miscreants surged once more; the Italian 10yr yield has reached 6.0% for the first time since the end of January. Latam currencies were also savaged; the Mexican peso for instance has dropped 6% against the dollar in just the past two weeks while the BRL is down more than 4%. Likewise, commodities fell hard – the gold price has opened up in London this morning down near USD 1,530 an ounce while WTI is close to USD 92 a barrel. Asian equities have been buffeted; the Kospi and Hang Seng fell 3%. There is very little prospect of the Greek uncertainty ending any time soon. The Greek President has been alerted by the head of the central bank that depositors are increasingly anxious about the safety of their savings and are pulling money out of local banks. Clearly, Greek citizens are not sufficiently reassured by the deposit guarantee scheme which exists in the country. It supposedly guarantees individual deposits with any bank or financial institution up to EUR 100K. The Greek deposit guarantee scheme can also (supposedly) borrow from other schemes around Europe in the event that it has insufficient available funding. No doubt the likes of Germany et al would be aghast if Greece were to put in such a request. Nevertheless, the risk of a significant bank run in Greece is now very real.
The shifting eurozone growth debate. As Europe pushes back against austerity, and the new pro-growth French president Hollande is sworn in, never before has there been such a focus on the growth numbers across Europe. The good news is that there is something for everyone. The optimists (and headline writers) can rejoice at the fact that Germany grew five times faster than expected at 0.5% QoQ (it’s a good job the market was not expecting zero quarterly growth…). We have to wait until next week for the more detailed breakdown of the principle drivers. France provides ammunition for those sat on the fence, the economy having stalled in Q1 and the Q4-11 outturn revised down to a mere 0.1%. Meanwhile, Italy contracted by 0.8% in Q1, a touch more than the 0.7% decline anticipated. The eurozone numbers showed a flat outturn for Q1, with six of the 17 members (not all have reported yet) officially in recession. Furthermore, Germany is the only major economy that has surpassed the pre-recession peak (2008-09) in overall output. What is lacking, however, is credible detail around the talk of a more pro-growth approach. The German SPD opposition yesterday has called for an ‘investment pact’ to replace the failed push for austerity that Germany (largely successfully) pushed through whilst Sarkozy was president of France. This is all well and good and could gain some traction in Germany, but for the others it’s going to be a hard sell for two reasons. Firstly, most government investment/infrastructure spending takes years to pay back. Secondly, markets may feel that governments are not best placed for such spending and that they are not the best allocators of capital. Having said that, given the performance over the past few years, many would argue that the private sector is hardly much better. Ultimately however it boils down to the faith markets have that more borrowing now is matched by a credible plan for reducing it at a later date. Given that the latter invariably falls beyond the scope of current governments (especially at the rate they are falling from power), such plans lack credibility in the eyes of markets and investors.
More RMB depreciation cannot be ruled out. Noticeable over recent months is that all those commentators and talking heads who have claimed for so long that China’s currency is massively undervalued have gone into hibernation. Because what has become abundantly clear is that the analysis that lay behind this claim was fundamentally flawed and incomplete. Recent developments in China will now hopefully trigger a more rational appraisal of the valuation of the currency, which so far this year has actually depreciated against the dollar, the pound and other major Asian currencies (except for the Japanese yen). Indeed, given the deteriorating state of the economy, further RMB depreciation cannot be ruled out. Two main forces have been weighing on the renminbi. Firstly, the economy is enduring a much rockier landing than expected. Most striking has been the stream of consistently weak key domestic economic indicators such as electricity production, rail cargo volumes, residential floor space construction, land sales and house prices. Business investment, a huge contributor to the Chinese growth story over recent years, has slowed markedly, hurt by declining global demand, higher operating costs and reduced profitability. Policy officials have been a little slow to respond to the deteriorating growth picture, perhaps distracted by the upheaval and political machinations within the Politburo. That said, policy-makers have enormous scope to stimulate the economy as and when they feel it is necessary; bank reserve requirements remain extremely high (notwithstanding the recent 50bp reduction), fiscal policy has a lot of potential to provide the economy with a powerful boost and key interest rates can be lowered significantly (although only once the inflation genie has been contained). With domestic demand-growth clearly more tentative it is not surprising that foreign capital-inflow has slowed markedly and that the currency is no longer rising. Secondly, those Chinese who have amassed wealth in the country over the past decade are becoming much more active in attempting to convert their bounty into hard currencies. Conscious that conditions in their own country are not nearly as favourable, high net worth investors have been transferring their wealth to safer havens such as property in major global cities, dollars, Japanese yen and the pound. In London, a major explanation for the rise in property values over the past year or so is the dominating presence of cashed-up Chinese buyers. Over the next couple of years, we can expect a lot more of this type of activity which will put downward pressure on the Chinese currency. From a political perspective, Beijing will be aware that a depreciating currency will create huge tensions, especially with the US. Also, China’s massive foreign exchange reserves could be used to thwart any downward pressure on the currency. At the very least, the indifferent display by the renminbi this year has neutralised expectations regarding future currency performance. Presently, the forward market actually anticipates that the yuan will fall by 1% over the next year. As we have been suggesting for some time now, during such a turbulent year, and not just economically and financially but also politically, Beijing was always likely to favour a relatively stable exchange rate.