Grexit or Grestay?

Greece took centre-stage once again this week, with the debt-ridden country leaning towards a ‘no’ as of Monday morning in Asia.

Greece flag
Source: Bloomberg

Despite the much reduced economic contagion risk of Greece, the Greek headlines are causing concerns for policymakers over what adverse impact a breakup could entail.

Clearly, European leaders are moving quickly to hold more discussions on the matter.

Japanese and South Korean officials are also debating the negative effects of a Greece ‘no’ vote, with BOJ Governor Kuroda saying that Japan has limited direct connections to Greek economy and finance.

Market uncertainty has also stepped up a notch and a flight to safety has ensued. Japanese equities fell over 1% in early trade, while the Japanese Yen strengthened against the euro and the dollar. EUR/JPY tumbled over 1%, to around 135. Yields on US 10-year treasury futures dropped over 3% and gold inched up modestly. It looks like Asian markets may be similarly affected, with the MSCI Asia Pacific Index slipping towards 145. Australian equities also fell more than 1%.

The period of market uncertainty during the wrangling of a deal or no deal will fuel volatility. To be clear, this vote does not mean that Greece will automatically head to the exit, but the prospects have definitely increased considerably. JP Morgan certainly sees a Grexit as its base scenario now.

The ECB will decide tonight if they will reopen the emergency liquidity facility for the Greek banks and it will be the first event to watch for global investors. Germany and France are convening a meeting of euro-area leaders on Tuesday to talk about Greece, although one gets the sense that creditors might not be willing to soften their stance.

Nonetheless, the ‘no’ vote may push creditors to reconsider Greece’s demands, that is, providing a substantial haircut (30%) to the debt, and lengthening considerable the repayment period (20 years). Market moves over next few days are going to be contingent on whether the two sides can come to a compromise. Given the deeply-seated perceptions on how to help Greece, the likelihood is very slim. 

Doubtless, the risk sentiments are going to be dampened for a while longer, especially when you factor in what’s going on in China.

China rolls out more initiatives

Chinese authorities and the financial sector are very concerned over the seemingly relentless sell-off in the equity markets. Over the weekend, a flurry of announcements was reported as they try to reverse the bearish tide we have seen for the last three weeks.

CSRC suspended IPOs and a group of Chinese brokers, led by Citic Securities, pledged to support not to sell shares as long as the Shanghai Composite remains below 4500. Moreover, the brokerages will put up at least CNY 120 billion ($19 billion) in a market stabilisation fund to buy into blue-chip ETFs. This was bolstered by a pledge by 25 mutual funds to buy shares and hold them for at least a year.

The situation has deteriorated to a state where confidence in the equity market was ridden roughshod, over despite recent slew of government measures prior to the weekend initiatives. Beijing blamed the persistent declines on short-sellers.

The problem is that the numbers do not back up this claim. Short interest on the Shanghai Stock Exchange was the lowest since July 2014, while the China Financial Futures Exchange reported that it did not discover any ‘large-scale’ selling. State media also seek to calm sentiments, calling for investors not to ‘lose their minds’ and be at a loss of what to do amid panic.

As often the case, it is hard to tell if the fresh measures will help. Chinese equity markets have a daily turnover of CNY 2 trillion and the amount of money put up to support the stocks is probably a little on the low side. However, this may just work, if investors believe that the authorities and industry will just come out with stronger measures, should the current batch falls short again.

We have seen that happen before when individual punters bet that the government will unleash more stimulus if the economy hung on to its slowing tune. For the time being, Chinese traders are increasingly nervous about the outlook of the stock market. It is quite likely that the decline may continue this week, however, the pace of the fall may be slower.

I feel that the volatility level will be an indication of whether the latest initiatives are having an effect. Based on Bloomberg charts, historical daily volatility for a six-month period for Shanghai Composite have remained at the highest level last week.

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