Global markets shed risk aggressively

Global markets had aggressively shed risk after Greece made a series of announcements, including calling a referendum, shutting banks temporarily and imposing capital controls. 

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Source: Bloomberg

Investors dumped both equities and selected sovereign bonds, preferring to seek a flight to quality.

US and European markets followed in the wake of the Asian stock tumble.

DAX and CAC plummeted 3.6% and 3.7% respectively, while their peripheral neighbours Spain and Italy plunged 4.5% and 5.1% on contagion fears. US equities dropped around 2%.

In the bond markets, we saw peripheral debt such as Spain and Italy widen relative to the German bunds. Quality sovereign debt were snapped up to levels before last Monday’s EU emergency meeting. Yields on German 10-year bund fell a massive 13bps to 0.80%.

Likewise, 10-year US treasury yield shed 15bps to 2.32%. In contrast, Spanish and Italian 10-year bonds added 24bps. This could be a knee-jerk reaction, and not a full-fledged contagion risk, although I will remain cautious on that front. Europe may have ring-fenced Greece from a mass fallout effect, to some extent, the probability of lumping them as risky debt by the fickly market is still a real risk.

The interesting development is that the resilience of the euro re-asserted itself in the overnight session. After falling to a one-month low, just below the 1.10, the EUR/USD was met with short-covering demands, rebounding back to high -1.10. We saw more buying coming in, as the pair leaped another one big figure to mid-1.12 levels.

There are talks that any adverse effects on the Greek situation would be contained, with German Finance Minister Schaeuble saying that he doesn’t view Greece as a contagion risk for the rest of the euro area. It appeared that there are some resemblance of calm returning to the currency markets. Even the implied one-month volatility for EUR/USD dropped below 14.0%, after spiking to as high as 15.3%.

Clearly, if you are concerned about the Greek crisis, being bearish on the European equities may be the most direct way to trade the situation. Going short on the DAX and the peripheral markets such as IBEX and MIB are possible ways to go about it for the next few sessions, and ahead of the 5 July referendum. Unlike the Chinese markets, the volatility in European equities is more manageable.

The rather spirited euro could make it a difficult trade. The odds of further losses on the single currency, however, are still looking more likely given the current predicament the Euro-area is in. As such, I feel EUR/JPY and EUR/GBP may still be two cross pairs to look at, as the JPY and GBP are still clearly the better risk-off currencies in the present environment.

Interesting day for Asia

Today will prove to be a very interesting day in Asia. Not only are the markets still reeling from the twin shocks over the weekend, the session will also be complicated by the end of month and quarter. The market will also watch whether Greece will cough up the €1.5 billion to pay IMF. It will be a disbelief if they do as everyone is expecting the country to ‘be in arrears’ with the IMF over the missed payment.

In China, I think the uncomfortable truth that the latest policy intervention has almost no effect in stemming the equity bleeding may be more shocking than the fact that there is more easing. The government is clearly reacting to the recent slump in the domestic stock markets as they not only cut key interest rates, but also lowered the reserve requirement ratio (RRR) for some banks.

It is telling that they cut a good 300bps off the RRR for finance companies. The dual rate cut is a rare occurrence, where the last time it took place was during the height of the global financial crisis in October 2008. For now, it could get tricky for the Chinese authorities as we may see a shift in the retail investors’ mindset where policy intervention may no longer be an impulse for equity bulls.

This will reduce the government’s effectiveness in managing the stock market. Meanwhile, it is a good idea to keep an eye out for more news on whether CSRC will halt IPOs for the time being until the domestic markets stabilise. For now, the downside momentum in Chinese equities remain tough to reverse.

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