However, that doesn’t completely explain the current situation.
The state of play
The bond market is painting the clearest picture. Spanish and Italian 10-year bonds added 24 basis points (bps), seeing yields back towards 2.5% as traders dumped peripheral risk – Europe may have ring-fenced Greek debt. However, the gate is ajar and contagion can still escape.
There is plenty of reporting about who is holding Greek debt. The break down is very interesting – the total outstanding Greek debt is €323 billion.
60% is held by the Eurozone - €141.8 billion is held in the European Financial Stability Fund and €52.9 billion in the Greek loan facility
10% is held by the IMF: approximately €32.3 billion
6% is held by the ECB: approximately €19.3 billion
15% is in ‘other bonds’ and 3% is in ‘other loans’
The Bank of Greece holds 1%
The key part on the contagion side is the 1% is from foreign banks
The interesting part of the debt breakdown is the fact Europe is on the verge of receiving a rather large haircut. Greek finance minter Yanis Varoufarkis is educated in ‘game theory’ – he knows Greek hurt will be transferred to creditors as the haircuts loom – but who blinks first?
However, no one has blinked since the SYRIZA party announced a July 5 referendum. France and Germany have stated that no new deal will be given. The question will be: What happens if Greece starts to default on all its payments over the coming six weeks? Foreign banks may be insulated from the pain but sovereign nations inside the Eurozone clearly are not.
What is also interesting from yesterday’s developments were the movements in the interbank market – Fed ‘lift-off’ expectations are rapidly falling back to December. I also note the Australian interbank market is now pricing in a 63% chance of a 25-basis-point cut for December. Conclusion: ‘risk off’ trading is rising and economic contagion fears are growing.
Clearly the EUR is the riskiest currency in the G10. The two pairs that we see as the best way to trade volatility are EUR/JPY and the EUR/GBP as both legged lower on the news, and then closed the gap and more following the European open. The JPY and GBP are clearly the better risk-off currencies in the current market.
If you are bearish about the Greek situation, the equity markets are the clearer opportunity - the volatility is more manageable in equities. Going short the DAX and peripheral markets in the IBEX and the MIB are the key choices over the coming few days.
There will be a point where this becomes overdone and the cover rally will rapidly pick up – it may even occur this week so keep that in mind when trading these names.
PBoC cuts goes off with a whimper
The fourth cut in eight months to the reserve requirement ratio and/or the lending and deposit rate was met with initial glee before seeing mass disorderly selling.
Several key Chinese indices limited down mid-way through the trading session yesterday before slightly recovering - it begs the question of what else policy makers can do? (Answer: not much)
It is a very bearish case for China in the short term. The trading situation that transpired yesterday clearly shows that once sentiment sours, policy interventions to shore up equities has a short lived effect, if any.
Depth screens are in for a torrid time over this period – profit is being eroded by the minute yet the buy side is empty. 1% intra-minute moves were common yesterday and will be over the coming period as Chinese equities rebalance.
If the slide does continue at its current pace and disorder reigns, the central government will shift its attention to shoring up the broader economy rather than worrying about the falls in equities. Further disorder will transpire when this eventuates.
Ahead of the Australian open
End of financial year – just to complicate things further today – it’s also the end of the month and the quarter.
Trade will be highly volatile as mangers close out the month, quarter and year with Greece and China as an overlay. The futures are down 34 points and we see the ASX opening down 25 points to 5397.5 – half a point off a technical correction from the year’s (and a six-year) high.
The fact it is the end of the year means sector and individual stock directions are very hard to predict today. However, the global risk-off sentiment should be the baseline for your strategy.
Glenn Stevens is also addressing the Monetary and Financial Institutional Forum in London tonight (6.40pm AEST) on ‘The Changing Landscape of Central Banking’. AUD will be in for an interesting European session.