Global Risk Off From China To Europe To US, As Greek Impasse Hits Markets

Another day of constant Grexit chatter, and this time the futures are really starting to react as what was seen as mostly impossible for the past 4 months is now considered virtually inevitable (even if as both UBS and MS say, very little if any of the upcoming contagion and volatility has been priced in).

The first tremors emerged when Greece announced it would not present a new proposal to the Eurogroup to unlock aid, relying instead on what has already been submitted and which the Troika said was inadequate. Then, confusing matters, a new GPO poll posted on Greece's Mega TV showed that increasingly more, or over 56% at last count, of Greece would prefer a "bad" deal with creditors than being kicked out of the Eurozone putting the future of Tsipras' cabine tin jeopardy. And then, hinting that the endgame is officially here, the FT reported that "Eurozone officials discuss holding emergency summit on Greece", suggesting a second Lehman weekend may be just around the corner.

As a result European equities slipped to a four-month low on Tuesday, with the lack of progress in debt negotiations between Greece and its international creditors making investors nervous and prompting them to cut their exposure to riskier assets like stocks. Greece's benchmark ATG share index fell 3.9 percent, taking total losses since Friday to about 14 percent, as Greece and its creditors hardened their stances on Monday after talks aimed at preventing a default and possible euro exit faltered.

Quoted by Reuters, Laith Khalaf, senior analyst at Hargreaves Lansdown, said that "the can of Greek debt has been kicked down the road so many times there comes a point when it has to be confronted, and it looks like that time may well be in the next week or so. A Greek exit from the euro zone is looking ever more likely, and seeing as no-one knows what the full implications will be, investors are taking some risk off the table which has caused the market turbulence we have seen in recent days."

The weight of the collapse of the Eurozone is strating to weigh German investor confidence slid to 31.5 in June, far below the 37.3 expected and the lowest level in six months, from 41.0 in May. It is also weighing on peripheral bond prices, with the Spanish 10Y yield rising above 2.50% earlier while both French and Belgian spreads to Bunds surged above 50 bps for the first time this year; even AAA-rated Netherlands and Finland are suffering.

Not helping matters was the announcement by the pro-ECB European Court of Justice which rejected the German Constitutional Court's finding that the OMT is illegal, and said Draghi's improvised Outright Monetary Transactions which nobody still has any idea what they are, is legal (although safeguards must be built in to ensure any such programme did not break rules that prohibit central banks from financing governments, unlike the ECB's QE) and as Reuters concludes, the "pro-ECB line of EU judges on Tuesday could set the European and German courts on a collision course." Because what the suddenly flailing European experiment needs right now is a fight with its anchor participant.

It wasn't just Greece: overnight China’s stocks fell again, capping the benchmark index’s biggest two-day loss this month, on concern valuations are outstripping earnings growth and a flood of share sales will lure funds from existing equities. And outstripping they are because looking at average or median multiples, Chinese shares are almost twice as expensive as they were when the Shanghai Composite peaked in October 2007 and more than three times pricier than any of the world’s top 10 markets. If the Chinese equity bubble has burst, a bubble which has added $6 trillion in market cap to the value of Chinese stocks in just the past year pushing them over $10 trillion or the same as China's GDP, then watch out below.

And just to add to the volatility, today the June FOMC meeting begins. While a rate hike announcement tomorrow is not expected (as the Hilsenrath mouthpiece would be screaming bloody murder), it is not off the table, and expect even more risk off sentiment to come as a result.

Looking at capital markets in detail, we start with Asian equities which  mostly fell led by the Shanghai Comp (-3.5%) which trade broke below 5,000 for much of the session, amid worries of a liquidity squeeze. This comes ahead of this week’s 25 IPOs which is said to lock-up as much as CNY 5.7trl worth of liquidity. KOSPI (-0.6 %) saw sharp losses weighed on by on-going MERS outbreak, after the South Korean Health Ministry confirmed 4 additional cases, bringing the total to 154. Elsewhere, the Nikkei 225 (-0.8%) traded in negative territory, after failing to capitalise on JPY weakness.

The sentiment remained a by-product of Greek related headlines, with the latest reports suggesting that Eurozone countries have agreed a contingency plan for Greece and are set to implement capital controls as soon as this weekend. Fears of contagion are clearly visible, with the gap in yields between German and other EU states widening and FR/GE 10y spread almost doubling in the last three trading days. As a result, Bunds (+84 ticks) remained supported, also benefiting from negative NCR in May/June/July, as well as ECJ’s decision in favour of the ECB’s OMT program. Also, to add fuel to the fire, German CDU whip stated that a Grexit is possible if no deal can be agreed, while Greek press reported that negotiations will take place today between Greece and Euro Working Group at 1900 local time. Separately, European stocks (Eurostoxx50 -0.9%) remained on the back foot from the get-go and while all major sectors traded in the red, healthcare outperformed given its defensive appeal in risk-averse conditions.

In FX, the initial surge higher in EUR/USD on touted short-covering and after stops were taken out above 1.1300 level, was gradually reversed and the pair now trades in the red. Of note there is a large 1.1200 option expiry set for 10am NY cut. GBP/USD also seen lower, as the release of an inline CPI headline reading UK CPI (May) Y/Y 0.1% vs Exp. 0.1% was overshadowed by lower RPI and the ONS House Price data which showed the biggest slowdown since April 2005.

The energy complex has seen more exciting sessions with price action in WTI and Brent limited due to a lack of fundamental news and the USD trading in a relatively tight range. However, comments from NOC’s Sanalla who stated Libya are currently producing 430,000bpd and hoped to reopen the Western pipeline after Ramadan which would send production to 800,000 bpd.

In addition to the start of the FOMC, on the US macro calendar we get Housing Starts and Permits, both of which are expected to decline notably from the April prints.

Bulletin Headline Summary from Bloomberg and RanSquawk

  • The ongoing Greek drama weighs on sentiment as sources report that the EU are considering implementing
    capital controls on Greece
  • The FT writes that Eurozone officials are holding an emergency meeting on Greece on Sunday amid fears that the
    impasse may lead to a possible 'Grexit'
  • Going forward, attention turns to the housing data out of the US, as well as API Crude Inventories report after the
    closing bell on Wall Street
  • Treasuries gain for second day as Greece rules out presenting new proposals to resolve debt crisis; Fed two-day meeting begins today, with rate decision, updated SEP and Yellen press conference due tomorrow.
  • Greece snubbed European pleas to submit a proposal to avert a looming default as the forces pulling the euro-zone’s seams apart grew ahead of a key meeting this week
  • Europe’s bond selloff is spreading to markets traditionally viewed as safer, with only Germany remaining unscathed by Greece’s impasse with creditors
  • French/German and Belgian/German 10Y spreads both surged above 50bps for first time this year; even bonds of AAA-rated Netherlands and Finland are suffering
  • The specter of insolvency in Greece poses the biggest threat to the legacy of German Chancellor Merkel whose political longevity rests on her crisis-fighting diplomacy
  • German investor confidence slid to 31.5 in June (est. 37.3), lowest level in six months, from 41.0 in May, amid risk of Greek debt default
  • The ECB’s 2012 bond-buying program won the backing of the European Union’s highest court, expanding ECB President Mario Draghi’s crisis-fighting arsenal
  • China’s stocks fell, capping the benchmark index’s biggest two-day loss this month, on concern valuations are outstripping earnings growth and a flood of share sales will lure funds from existing equities
  • Looking at average or median multiples, Chinese shares are almost twice as expensive as they were when the Shanghai Composite peaked in October 2007 and more than three times pricier than any of the world’s top 10 markets
  • Sovereign 10Y bond yields mostly lower. Asian, European stocks slide, U.S. equity-index futures fall. Crude oil mixed, copper and gold lower

US Economic Calendar

  • 8:30am: Housing Starts, May, est. 1.09m (prior 1.135m)
    • Housing Starts m/m, May, est. -4.0% (prior 20.2%)
    • Building Permits, May, est. 1.1m (prior 1.143m, revised 1.140m)
    • Building Permits m/m, May, est. -3.5% (prior 10.1%, prior 9.8%)
  • Federal Open Market Committee meeting begins

DB's Jim Reid completes the overnight event wrap.

Will the Greece stand-off be resolved within a week? Well there's a good chance it won't be as the divisions still appear wide. This Thursday's Eurogroup meeting might come and go without agreement. If so that's probably within a couple of days of being the last chance to enable sufficient time for a staff level agreement to pass through the various domestic and institutional approval frameworks (assuming no Greek referendum needed) so monies could be disbursed in an 'orthodox' way to Greece to avoid IMF non-payment on June 30th.

However we still have the Heads of State and Government summit on 25-26th June. If there was an agreement then it’s possible that a fudge or extension could be made to the current program to allow payment at or soon after the month-end deadline. The ECB would have to be onside and perhaps raise the ELA and t-bill cap to free up funds for Greece before a disbursement is made. But this is perhaps only realistic if a staff level agreement has been made by the last few days of the month. So it’s possible this could go deep into June before we know whether the worse case scenario has been realised or averted. A need for a referendum could complicate matters but it’s still feasible that the ECB may buy them time to have one even if a staff level agreement is only reached in late June. So it seems it’s possible that I can go on holiday for a week and for not much to have moved on. We'll see!! It’s almost impossible to second guess timing and outcome at the moment.

It was another of negative headlines on this ongoing saga again yesterday. German newspaper Suddeutsche Zeitung highlighted that Greece may be asked to impose capital controls this weekend should no deal be reached by then, while also noting that an EU leader summit could be possible for Friday in the case that no deal is agreed at Thursday’s Eurogroup. Greek PM Tsipras continues to remain defiant meanwhile, saying that ‘we will wait patiently for the institutions to adhere to realism’ while Greek spokesman Sakellaridis said that ‘we have largely reached our limits’ and that the country’s Creditors would have to show a willingness to compromise before Greece accepts. On the other side the ECB’s Draghi meanwhile reiterated that the ‘ball lies squarely in the camp of the Greek government to take the necessary steps’ while Bundesbank President Weidmann highlighted that the likelihood of no agreement being reached is only rising.

It was therefore unsurprising to see a sell-off in risk assets yesterday. Having tumbled at the open, Greek equities finished -4.68% on the day, led once again by a fall for the banks (-8.46%). There was similar weakness in Greek bonds yesterday where we saw both the 2y (+311bps) and 10y (+37bps) parts of curve climb to 28.2% and 11.7% respectively. That weakness meant we saw pressure in the peripherals yesterday as 10y bond yields in Italy (+13.8bps), Spain (+16.9bps) and Portugal (+21.1bps) all moved higher for the second consecutive session. Core government bond markets in Europe appeared to benefit from more of a safe haven bid however as we saw 10y Bund yields tick down 1bp to 0.822%, while similar maturity yields in Sweden (-3.6bps) and Switzerland (-2.8bps) also closed tighter. Other European equity markets softened, with the Stoxx 600 (-1.63%), DAX (-1.89%), CAC (-1.75%), IBEX (-1.71%) and FTSE MIB (-2.40%) all tumbling. Having fallen as much as 0.7% intraday, the Euro actually ended the day a tad higher versus the Dollar (+0.15%) at $1.128. There was some significant weakness in credit meanwhile as Crossover in particular ended 16bps wider.

The other big story this week is of course tomorrow's FOMC conclusion. Yesterday’s mixed US data certainly helped confuse markets leading into the meeting. The positive data-flow yesterday came in the form of the housing market where we saw the NAHB housing market index for June rise 5pts to 59 and above market expectations of a 56 print to tie the post recession high in September last year. The data leading up to this was decidedly weaker however. In particular, the June empire manufacturing print (-1.98 vs. +6.00 expected) and May manufacturing production (-0.2% mom vs. +0.3% expected) readings were disappointing, the former dipping into contractionary territory after a modest rebound in May. Industrial production (-0.2% mom vs. +0.2% expected) also did little to help lift the mood while the April revision saw the print taken down another 20bps to -0.5%. Finally capacity utilization fell 0.2% to 78.1% (vs. 78.3% expected), extending the recent downward trend in the data series. There is more important housing market data today when we get housing starts and building permits data in the final releases before tomorrow’s FOMC. Our US colleagues note that the NAHB index provides a decent leading indicator for housing starts and should therefore point towards a decent uptick for starts versus the April reading.

A combination of a bid for safe haven assets and also the soft manufacturing and industrial production numbers helped support something of a bid for Treasuries yesterday. The benchmark 10y eventually finished 3.6bps lower in yield at 2.357%, although it briefly traded as low as 2.311% before the housing market data. Meanwhile, after a 1% fall at the open, the S&P 500 recovered somewhat over the course of the session, eventually finishing -0.46%. It’s interesting to note that despite all the volatility out of the Greece saga, the S&P 500 hasn’t had a +/- 2% daily swing (based on closing prices) since December 18th last year. By comparison, the DAX has moved by that amount 14 times in the same time period. It was a fairly subdued day for the Dollar meanwhile yesterday, with the Dollar index falling a modest 0.13%. US credit markets also succumbed to the risk off environment as CDX IG ended 2.7bps wider. Elsewhere, oil markets continue to remain weak as WTI (-0.73%) and Brent (-1.07%) both declined for the third consecutive session.

Refreshing our screens this morning, bourses in Asia are largely following the lead from Europe and the US yesterday having retreated in early morning trading. China equity markets are leading the declines, with the Shanghai Comp (-1.34%) and Shenzen (-1.79%) in particular tumbling for the second consecutive day. Elsewhere, the Nikkei (-0.56%), Hang Seng (-0.34%) and Kospi (-0.83%) are also lower in trading this morning. The JPY has been fairly active, falling as much as 0.4% versus the Dollar after BoJ Governor Kuroda said that he hadn’t meant to predict a future nominal exchange rate last week when talking about the Yen’s recent weakness. The Yen has pared some of those moves however and is currently 0.12% down against the Dollar. Elsewhere, US 10y Treasuries are another 1.4bps tighter this morning, while yields in Asia are generally mixed.

Just wrapping up yesterday’s data in Europe, Italian CPI was as expected for the month of May with no revision to the final +0.2% annualized reading. Euro area trade data for April pointed to a slightly higher seasonally adjusted surplus at €24.3bn (vs. €19.0bn expected) from €19.9bn last month. Elsewhere, the ECB’s latest weekly figures from its purchase programme indicated little evidence of any front loading of purchases after €10.7bn of public sector purchases were made last week. The ECB’s Draghi, in addition to his comments on Greece, reiterated that ‘it is our clear intention to purchase public and private assets of €60bn a month until September 2016’ and that ‘we remain prudently confident that all economic and monetary conditions are in place to support a gradual reflation of the euro area economy’.

Looking at today’s calendar now, we’ve got a fairly busy schedule in the European timezone this morning with German CPI due along with the May readings for UK CPI/RPI/PPI. Euro area employment data is also expected while there will be focus on the June German ZEW survey print. Focus in the US this afternoon meanwhile is on the aforementioned housing starts and building permits data while the Greece situation will likely continue to generate plenty of headlines.