The politics of game theory

The macro risk is at its highest level in four years. The US VIX had until recently been logging consistent ‘complacent range’ prints for several months despite Fed lift-off risk and Greece.

Greece
Source: Bloomberg

However, in the past week it has risen 33% with an intra-week rise of 53% in the five days between June 23 and June 29. European volatility indices are within touching distances of their 2011 and 2012 peaks. Australia’s VIX index reached its highest closing level since June 2013 on Monday and remains at yearly highs despite two days of positive prints.

The political and macro risk is finally being priced in (somewhat), which is why the VIX indices will be the indices of choice for strategy direction in the coming months.


Game theory

The game politics from Athens is ramping up spectacularly – early in the European session Prime Minister Tsipras said he would accept the deal with a few added concessions in an open letter to creditors. European markets rocketed on this release but the written proposal was again promptly rejected.

German Chancellor Merkel has laid bare her thinking, saying no deal will be done until after the 5 July referendum – therefore the prospect of the referendum being cancelled must now be in single digits.

Tsipras has now gone back to the people and continued to campaign for the ‘NO’ vote. This is politicking at its best.

In the eyes of the people, Tsipras would appear to be on their slide - ‘trying to find a deal’, while the creditors (aka the Eurozone) would appear obstructionist and are heaping this pain on Greece. It’s textbook game theory: he had no intention of agreeing to a deal and used the media perfectly to portray this scenario with the open letter last night.

The creditors know this and the fact Tsipras is the one that called the referendum, plus put the creditors into a position where no creditable negotiations can play out shows how well he is playing the politics.

Politics aside: market risk is growing. The spreads between Spanish and Italian 10-year bonds versus German bunds has the potential to balloon as much as 200 to 250 basis points the longer Greece has capital controls imposed on it and is in arrears to the IMF.

On the IMF ‘default’ issue, the S&P released a statement that should sharpen the focus of what a ‘default’ is in their eyes. This is key to the timelines Greece has on the rest of its repayment program. If you haven’t seen it, here is the crux.

“We would declare a Greece default if and when the Greek central government missed a payment on a commercial obligation. Greece’s upcoming commercial debt payments include €2.0 billion in treasury bills due on July 10; €83 million on a Japanese yen obligation, due on July 14; and €71 million in interest, due on July 17 on a three-year commercial bond the government issued in July 2014. About €39 billion of Greece’s total medium- and long-term debt is commercial, representing 22% of GDP. All of the remaining €261 billion in debt (excluding €15 billion in treasury bills) is owed to official creditors”
S&P statement

The spreads come a Grexit scenario are wildly varying in estimates but the consensus estimate is for them to be as high as 400 basis points – the ECB is key here and if it is proactive (which you would expect it would be), a 300 basis-point spread is more likely.

The VIX indices to therefore watch are the European rate VIX indices and the call/put spread ratios. If these ramp up, the market is clearly suggesting contagion is probable.

The equities front is a similar story - the DAX is the clearest indicator of overall risk in European equities and sustained selling will indicate a Grexit risk and further capital controls are likely.


Ahead of the Australian open

Complicating trade over the next three trading days is the extended US weekend for the 4th of July celebrations.

Non-farm payrolls are released tonight (not the normal Friday release) and US investors are now ‘in front’ of the market in a time sense, something they are not used to.

The fact US investors will not have Friday afternoon to assess how European markets close heading into Sunday’s vote means all positioning will have to happen tonight – something Asia is very used to doing. But not US investors.

That could possibly see selling in the US session tonight despite a positive NFP or other good US data. US investors will not want to be holding risk with such a big unknown happening on Sunday and I suspect Asian trade will be very busy today as it assesses the macro risks of the next 48 hours of trading.

We are currently calling the ASX up 12 points to 5527. However, the trade balance is due at 11.30am AEST and another record deficit is expected at 2.2 billion - the AUD and cyclical material names are the ones that are likely to react to the data and the market as a whole has a lot to assess.

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