The US dollar is enjoying broad gains today. It is extending its recent gains after a consolidative session yesterday as investors tried digesting the weekend developments. The yen is the sole exception among the majors. It is managing to hold its own against the dollar.
The euro has been pushed back to the $1.0950 area, seen in response to the initial Greek referendum call. A report in the Greek paper eKathimerini claims that 16 of 18 eurozone members are willing to let Greece exit the monetary union. While it sounds ominous, it need not be. The point is that Greece does not want to leave the monetary union. It will have to be pushed out. Letting an unwilling party leave is one thing, ejecting it, is altogether something else.
Some observers argue that Greece wants to stay in but does not want to meet the conditions of membership. This too sounds smart, but the precise conditions are not readily apparent. Like a football game, violation of the rules has been incorporated into the game itself. Germany and France were among the first to violate the Stability and Growth Pact. They voted against being fined. France and Italy have repeatedly not delivered budgets in line with agreements with the EC. The violation of rules by themselves cannot therefore be grounds for dismissal.
The ECB left the ELA cap unchanged while adjusting the collateral haircut. The details on the haircut are not known, but it is understood that there will be an increase in the haircuts. Remember that a range of assets is used for collateral and not all collateral is given the same haircut. The principle involved is that Greek banks use government-linked securities extensively for collateral. This government link is becoming more toxic.
The risks associated with ELA lending are shouldered by the national central bank. It is not a function of the ECB's monetary policy, for which it was recently granted wide berth by the European Court of Justice. It is not clear the extent of the ECB's authority in ELA. However, the ECB's claim seems to be that what it can enforce is the ban on central bank financing of the government. ELA funds going to banks must not be used to fund the Greek government, and that line gets blurry given the deterioration of the government's creditworthiness.
The ECB will meet tomorrow to review Greece's ELA. The ECB apparently hopes for greater clarity of the larger political signal. Today there is a finance ministers' meeting prior to the heads of state summit. One implication is that the bank holiday will continue through Wednesday (and we suspect longer still). We have argued that at this juncture, the issue is no longer will Greece's debt burden be reduced. It is a question of how and the terms. European officials can try to control the process and exact concessions, or it can abdicate its responsibilities and political common sense and accept a disorderly default, thus risk triggering a chain of events whose outcome and consequences are far from clear.
There are a few other developments in addition to Greece that are on investors' radar screens today.
1. The RBA left rates on hold. The central bank did not appear to break new ground or adopt an overtly dovish bias. Many will still expect a rate cut in the coming months, but an August move is not a done deal. The Australian dollar was still sold to new multi-year lows, pushing through the $0.7450 barrier. Weakness in commodity prices, soft data (construction PMI), and the continued sell-off in Chinese shares are among the commonly cited drivers. Many are talking about a move toward $.7000.
2. Sterling remains under pressure as the market reconsiders the BOE rate hike trajectory. Since June 26, the implied yield on the June 2016 short-sterling futures contract has fallen by more than 20 bp. The yield has fallen further today on the back of a much sharper than expected decline in manufacturing output. The 0.6% decline in May is the second consecutive monthly contraction. The consensus had expected a small gain after the 0.4% decline in April. The fact that overall industrial output was up 0.4% (compared with expectations for a 0.2% decline) left little impression. The $1.5460 area that sterling has approached is a retracement objective of the leg up that began on June 1. A break of that area could signal another cent decline before bottom pickers may be more tempted.
3. The fall in Chinese shares continued with the Shanghai Composite off 1.3% and the Shenzhen Composite shedding 5.3%. Bloomberg is reporting that trading has been halted on about a quarter of the companies that account for the listed stock market capitalization of those exchanges. This compares with 0.2% in the US and almost 5% in Hong Kong. China's policy response to the precipitous decline in the equity market appears to be jeopardizing its reform agenda which included giving market forces great sway. It raises questions about readiness to join the global equity indices, which MSCI recently declined to do. It also supports critics' claims that Chinese officials are not willing to sacrifice the kind of control that is necessary to open its capital account, which is seen as a prerequisite for truly internationalizing the yuan and promoting its use as a significant reserve asset.
4. Oil prices are stabilizing today after the recent steep slide. The price of Brent and WTI fell by the most in several months yesterday. Last week's news that the US increased its drilling activity for the first time in eight months and reported the first rise in oil inventories in nine weeks pulled prices lower. Negotiations over Iran's nuclear program were to reach a conclusion today. Although the negotiations will likely be extended, the prospect of more supply in the form of Iranian output also weighed on psychology.