The three main macro issues at the centre of markets this year all come into full effect this week, with China, Greece and US economics all dominating news flow.
The monthly US jobs report is announced on Thursday, with expectations of 230,000 jobs created. Still, traders will be more concerned with Greece and China, as another solid payrolls report is hardly going to alter the fact Chinese authorities seem genuinely concerned by the massive equity deleveraging. The European Monetary Union is also in complete disarray.
For many the weekend was spent trolling through various headlines from key EU creditor personnel to find out what exactly was happening, not just around the referendum, but also Greek banks’ capital controls. We now have a good understanding of the controls in the Greek banking sector, but the referendum is just filled with so many implications – especially if they vote ‘yes’ – which I personally suspect they will. New polls just released for Proto Thema showed 57% of participants said they would vote in favour of agreement, even if it meant further austerity.
A ‘no’ vote is a straightforward rejection of the EMU. However, it is clear that the current Greek leadership is not compatible with the EU’s top dogs. There seems a strong disconnect between remaining in the union with Tsipras and Varoufakis providing direction and the EU providing any aid, which is of course the area we most need to see a new proposal re-established! A ‘yes’ vote is therefore where the confusion lies and this seems the most likely outcome.
Naturally, confusion leads to selling and volatility, and this is exactly what we saw on open. FX markets were a trader’s first port of call and EUR/JPY immediately kicked in with a monster 400 pip sell-off. S&P futures were sold close to 2% on open, but have recovered somewhat, which has driven some buying in Aussie and Japanese shares, but both markets are getting smashed today and look highly vulnerable to further selling – a short seller’s favoured hunting ground.
Safe haven buying has really been limited to fixed income, with a solid 15-basis point move lower in US treasuries futures. Gold has done very little (currently up $8) and you really have to look at it in EUR terms to get any real performance.
Still, despite calls from some (including the Austrian finance minister) that a ‘Grexit’ is inevitable, mass panic selling hasn’t resulted. That could still change, although the European open is shaping up for sizeable drawdown.
It seems that we are in for a period of underperformance from European equities and for that it is worth looking at the Eurostoxx/S&P 500 ratio. This has moved from a ratio of 1.76x to 1.89x in the last couple of months (I’ve looked at both markets in AUD terms). It seems logical that the ECB will promote a firm commitment to provide liquidity but, given the uncertainty, we could see Europe resume a period of underperformance and this ratio head lower. This is in line with a one-standard deviation move from the regression line drawn since the highs from 2008.
Still, it’s the moves in Chinese equities which have been talked about and the bulls won’t be pleased that after the PBoC injected RMB650 billion into the economy (through its weekend easing measures), markets have peeled back earlier gains to resume the two-week drop. The bears will say this is a clear sign that the Chinese markets have another 20% downside. Calls from the Chinese central bank to stop selling and start buying again hasn’t materialised and there is no doubt this is a bearish development.
It promises to be a very interesting session in Europe and I think a number of Asia-based traders will be keen to see the European reaction before putting money to work. One thing which has already started working nicely is volatility, with one-month implied EUR/USD volatility spiking 26% to the highest levels since 2011. The Eurostoxx and S&P 500 VIX should also see a strong move higher as well, as traders seek put protection.
Elsewhere expect a significant widening of Italian and Spanish spreads relative to German bunds (i.e. long German debt, short peripheral bonds), while EUR/JPY and EUR/GBP look like a sell on a squeeze higher into this morning’s gap.