Focus may switch to Fed amid Greek saga

The media may concede some parts of its obsession on Greece to the Federal Reserve later this week, as the market eyes are on US non-farm payrolls data.

Federal Reserve building
Source: Bloomberg

US Consumer Confidence beat consensus indicating an improving consumption outlook, while Fed vice chair Fischer commented that the FOMC is close to meeting its inflation goals, and has already met its employment objectives.

He expressed confidence that the US economy is growing at a fine pace. But what stood out from his remarks was his view that the monetary authorities should not wait until they have achieved their objectives before adjusting the policy, as the impact of monetary policy has a lag effect.

It is likely that Mr Fischer is not the only one sharing this view. This suggests that the consensus of a September lift-off remains on the cards. However, the ramifications of the Greece situation are still murky and hence complicate Fed’s monetary policy decision. While there are many who argued that any financial contagion is expected to be limited, we are not so sure, especially looking at how the European markets react to the regional developments.

An important question on the minds of many is whether the Greek crisis will spread. The truth is any contagion risks largely depend on how European investors and people view the imminent fallout in Greece. If they believe that their governments might also default on debt, we could see a rush to get money out.

At the same time, demand for sovereign debt would disappear. The peripheral economies remain vulnerable to such a scenario. This is exactly what we see in the bond markets. The spread between 10-year Italian bonds and German bunds widened sharply recently to the largest in seven months. We also saw the same market response in Spanish and Portuguese sovereign debt.

That said, the ECB QE programme is helping to head off some of this risk. They are already buying debt and can step up the scale of the stimulus if necessary. This suggests that the immediate fallout may probably be contained.

An outcome from the 5 July referendum now becomes vital. Greek PM Tsipras is calling for a ‘No’ vote, arguing that it will give him more ammunition for negotiations. In this scenario, the country will likely halt all debt repayments, particularly the more important €3.5 billion debt repayment to ECB on Monday 20 July.

I feel that this will accelerate the expulsion fate of the country and result in an economic collapse. We could see a sharp GDP contraction over the next few months. The next big uncertainty will be how long Greece will take before its economy stabilise.

It is really difficult to assess the impact of a Grexit. However, if the public votes ‘yes’, we could either see the present government reorganises itself, shedding its hard stance, or they could resign and make way for a new administration.

Will the Greek crisis spread to Asia?

It seems that Asia may be spared from the Greek crisis, owing to several factors. Firstly, this crisis has been five years in the brewing, and the slow grind towards increasing prospects of a Greek exit should not come as too big of a surprise to the markets. Secondly, a large proportion of outstanding Greek debt is owned by countries (mostly Germany and France), instead of the private sector. Thirdly, Asian countries have a solid reserve buffer. Nevertheless, if the Greek woes affect the Eurozone growth, and led to further losses on the euro, we could see Asian exports weaken.

More support for China?

While traders may heaved a sigh of relief after Chinese markets rebounded yesterday, I remain sceptical on whether the recovery is sustainable or not, given the persistent drop in margin lending.

There is a belief that the bears merely took a breather and may take to the fields soon. Still, if there are more support coming out from the government, we could see the bears kept on the sidelines for a while. On the data front, official manufacturing PMI for June came in unchanged from the previous month at 50.2 and underwhelm consensus of 50.4.

Activity in larger manufacturers continued on an expansion path for the fourth month, furthering the view that the economy is showing signs of stabilisation. In contrast, the Markit PMI reading, which polls the medium to small manufacturers, remained in contraction zone, and the final reading for June will be due shortly today at 0145GMT.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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