Chris Weston, Chief Market Strategist at IG Markets
Greece is solved, so get involved as some say; but this is far from the truth.
My personal belief is that those previously calling for Greece to leave the European Monetary Union would not have changed their call; in fact they would even argue their case has strengthened. It really seems as though Germany is slowly managing Greece out of the Union, although this process probably started back in 2012 by reducing banks’ exposure to Greek debt.
To put Friday’s developments into context, all we have seen so far is simply an agreement to enter into what will no doubt be complex and painful negotiations. Judging by our client flows today, traders have been only modestly enthused by the agreement, although the European market open is shaping up to be a positive affair.
The idea that the Greek government will ultimately sign off on the sorts of fiscal targets and structural reforms that will satisfy the hard-lined stance of the Eurogroup is yet to be seen. So, while this may indeed lead to a snap election, Greece will also be cognisant that it faces €6.7 billion in bond redemptions in July and August; so unless there is firm agreement in the upcoming negotiations, then Greece will default.
Will Greek negotiations even make April?
Negotiations may not even make it to the proposed deadline of April, as Greece doesn’t actually have enough money to make a €1.6 billion loan redemption to the IMF in March. What’s more, the Greek Treasury Department has already hit the limit on the level of short-term debt instruments (T-bills) it can issue. So the immediate funding issue will need to be addressed with the €15 billion borrowing cap raised, or the April deadline will need to brought forward to March. Given the magnitude of what’s at stake here, it’s hard to see how Greece can work to that aggressive time-line.
Still, the European Central Bank’s (ECB) quantitative easing program kicks in next month and this seems to be the key driving mechanism. Valuation wise, Europe is trading on a valuation discount to the S&P 500, while earnings are expected to grow 12%. There are even signs of economic green shoots emerging, which could drive a potential earnings per share (EPS) upgrade cycle, something that traders just don’t associate with Europe. What’s more, European banks have underperformed of late, but I feel that will change as the central bank showers European banks with liquidity, understanding that some 70% of domestic companies’ external funding comes from the banking sector. This sounds reasonable, but in the US, corporates generally source funding from alternative sources (such as the markets).
Japan is also flying with the corporate landscape looking more and more compelling for equity investors. In Japan, central bank reflation meets capital management, and as a result the Nikkei is flying. The Bank of Japan (as seen in today’s minutes) are still of view that inflation is likely to reach 2% in or around 2015, although one member on the committee doesn’t think it will achieve the desired 2% in 2016. I am not sure about the collective view and this is certainly not shared by the bond market, although there is also a scepticism that the central bank will add to the current program. Interestingly, the vast majority of Japanese firms don’t feel there is a need for additional easing, which will hold the Nikkei back a bit; however there are still kickers other than a weak JPY to help drive upside appreciation.
Aussie banks supporting local trade
The ASX 200 has seen slightly more upbeat flows today, but I still think the ‘value’ long trade is closer to 5740. Earnings have not been overly impressive, at least relative to a number of overseas developed markets; however pay-out ratios have generally increased and importantly dividend growth is far in excess of earnings growth. Still, today it’s been the banks that have supported the market and they will be in focus this week, with domestic capex in focus and wage growth potentially growing at 2.5% – a record low.
Weakness in the spending plans could increase expectations around a March hike, with the interbank market pricing in a 48% probability as it stands. AUD/USD bulls will need to see a break of $0.7884; however my antipodean preference is for NZD/USD shorts between $0.7550 to $0.7600.
The focal point of the week remains Janet Yellen’s two key note speeches. The prospect of more upbeat language is real and this continues to play into my view that EUR/USD is a potential sell into $1.1450 to $1.1500, with USD/CAD also looking quite compelling from the long side, especially with US crude finding good supply into $55.00.