Chinese Recovery, Grexit Threat Keeps Traders Guessing

Capital markets currently have so many moving parts to contend with that it’s no wonder that volatility trades atop a multi-month high. If it’s not Chinese officials trying to prop up the Shanghai Composite index in fear of economic setback and social unrest, then it’s Greece that’s been triggering the market’s risk on or off trading strategies.

Prime Minister Alexis Tsipras is under the gun to produce an acceptable reform proposal to Greece’s international creditors on Friday or his country will incur the wrath of its eurozone counterparts on July 12.

In the background there is the Federal Reserve, wanting to begin its rate normalization policy, but officials are somewhat vague in their timing as yesterday’s Federal Open Market Committee (FOMC) meeting minutes indicated. The minutes highlighted the external risks the FOMC is fretting over, and that could delay the Fed’s first rate hike. The market had priced in a June rate lift-off, then it was July, and now September even seems a stretch to the fixed-income trader.

Despite the current event risks, forex price action remains fluid and relatively contained. There are certain pockets of unexplained price action, but in general, market moves remain relatively orderly and easily explained away.

Equity Relief Rally

In the overnight session, China’s Shanghai Composite opened down by over -2%, but risk-on sentiment quickly replaced the panic selling of the last few days. Investors seem to be responding to their own government’s fresh measures specifically targeting the equity selloff. Loans to China’s Securities Finance Corporation enabled it to inject liquidity directly into the stock market and pushed the bourse well into the black at the close.

However, it’s not the overnight action that the market should be concerned about, but the impact of the recent correction in the index. The knock-on effect has yet to show up. It will take some time before the market can assess whether Chinese officials have been able to divert slower growth or stave off a financial crisis. More importantly, will authorities be able to win back investor faith? If not, many Chinese assets should be priced much lower going forward.

Yen Loses Safe-Haven Demand

The stabilization of global equity markets has managed to take off some of the safe-haven appeal of the yen (¥121.40). This week it has been the specific go-to safe currency of choice since the Swiss National Bank’s (SNB) veiled threats of how it would handle an overvalued CHF. Ever since the SNB unexpectedly scrapped its €1.2000 currency cap last January, the market has been rather wary of being too ‘long’ CHF.

Even the EUR (€1.1050) remains somewhat steady as both traders and investors believe that the European Central Bank is better equipped to address any uncertainty should a Grexit occur. President Mario Draghi and his fellow policy members have been very vocal about their available arsenal (quantitative easing, Securities Markets Program, Outright Monetary Transactions) to avert contagion. Orderly pricing of eurozone periphery bond yields certainly proves their point. Other investors even believe that cutting out the eurozone’s weakest link is positive, and it’s this that may even persuade them to buy EUR-denominated assets.

Because of the hastily called referendum in Greece, the adamant “No” response and the hardline stance of its creditors, it seems that Greece’s exit from the eurozone is being considered the most likely outcome. This could occur either in the short term, over the next few months, or it could even be dragged out over the next few years.

This Sunday the market is expecting clarity. No matter what unfolds, for traders and investors it will be the third consecutive weekend to experience event-risk market pricing. The next move remains with Greece as the market waits to see if its proposal to secure a third bailout is accepted by its creditors.

The Old Lady Holds Steady

The Bank of England (BoE) kept its benchmark interest rate unchanged at +0.5% and its bond-buying program at ₤375 billion on Thursday.

Despite the grim economic outlook in other parts of the world, the United Kingdom’s economy grows solidly. To that end, the International Monetary Fund (IMF) expects the U.K. to grow by +2.7% in 2015 – second only to the IMF’s +3.1% prediction for the U.S. among the Group of Seven economies. Unemployment in Great Britain is at its lowest level since 2008 while annual inflation remains below the BoE’s +2% target. The BoE’s Monetary Policy Committee (MPC) made no public statement following the rate announcement.

No doubt the growing Grexit threat is of concern to the MPC, but so too is the rate of British wage growth. Chancellor George Osbourne recently introduced an increase to the country’s minimum wage for adults aged 25 and over during the Conservative government’s budget announcement yesterday. That could spur the MPC to seriously mull an interest rate increase in the coming months.

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