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June 21, 2015

Greece Casting A Long Shadow on Markets


The Greek drama is approaching the long awaited climax. An emergency heads of state summit will be held on Monday, followed by the regularly scheduled summit later in the week. At the same time, the banking crisis threatens to eclipse the sovereign crisis in terms of urgency.  

The accelerated flight of deposits from Greek banks, and the two extensions of ELA lending last week warn of the untenable status quo.  Without that extension of ELA lending before the weekend, an ECB official expressed concern that Greek banks might not be able to open on Monday

European leaders use the threat of a Grexit to try to force the Greek government to capitulate.  There is no necessary economic connection between default and being forced out of monetary union.  Greece's has restructured its debt to the private sector in 2012 within the monetary union. Cyprus bailed in depositors and instituted capital controls within the monetary union.   

Common scenarios of an exit from EMU were based the hypothetical desire from very strong (Germany) or the weak (Italy) country to return to their own currency.  This is not the case in Greece.  The people are not crying for a new drachma. Many understand what so many economic observers do not:   Greece suffers from the lack of a significant export sector.  This means that the projected advantages for Greece of devaluation are often exaggerated.   

Nor is it clear precisely what high law or treaty that a default would violate.  By the highest law, the euro is an irrevocable currency union.  European officials take pride in the rule-based system, and yet they threaten to abandon those same rules when it is convenient or politically expedient to do so.  

In moralistic terms, which seems to imbue discussions of the responsibilities of debtors, the original sin here is not that Greece lived beyond its means.  After all, this predates the existence of the monetary union.  Moreover, the debt overhang problem affects all countries in the euro area, including Germany.  Indeed Germany's refusal to expand fiscal policy (and, in fact, pay down some of its debt) despite low interest rates and the fiscal consolidation elsewhere is a source of much consternation in Brussels and Washington.  

Rather, the original sin here was the European governments violation of the Stability and Growth Pact and Maastricht Treaty prohibitions against fiscal transfers.  They gamed the rules by making loans to Greece that were used to service its private sector debt.     European officials recognized the unusual nature of what they were doing and created institutional capacity (e.g., EFSF/ESM) and bail-in rules so they would not have to do it again.  This is to say nothing about their motivations, which may have been noble (broad contagion),  mercenary (protect large banks), or base (pride). 

II

The US economy is accelerating.  Data in the coming days will show that consumption, capital expenditures, and home sales are improving.  Durable goods at the headline level may be held back by the drop in Boeing orders (11 vs. 37), which some attribute to the normal slow down orders before a large airshow (Paris).  However, the details, orders, excluding aircraft and military orders, which is a proxy for capex, is expected to rise 0.5%.  This would do a little more than offset the decline in April.  However, the Q4 14 and Q1 15 monthly average was a decline of 1.2%. 

Similarly, shipments excluding aircraft and military goods is used to calculate GDP.  The monthly average in Q4 14 and Q1 15 was -0.5% and -0.6% respectively.  Even if May is flat, the three-month average would be positive.  

Existing home sales are expected to recover from April's 3.3% decline while new home sales are expected to gain on top of April's 6.8% gain.  The best news though will likely be in May personal income and consumption figures.  Income is expected to have risen by 0.5%.  It has averaged 0.3% over the past three and six months.  Expenditures are expected to rise their most since last August (0.7%).  The strength of the retail sales suggests upside risk here.   A 0.9% gain match the August 2009 gain recorded as the US was emerging from the recession.   Personal consumption expenditures have averaged 0.2% over the last three months and 0.1% over the past six months.  

It appears the US economy is growing here in Q2 at probably a little more than a 2% annualized pace.  At the same time, the contraction in Q1 appears to have been largely revised away. What was a 0.7% decline is likely to be revised to as little as -0.2%.  The revision is too backward looking to elicit much of a market response, but it is important.  It means that the US economy is likely to expand around 1% in H1.  The lower end of the Fed's new central tendency is 1.8%.  That is unduly pessimistic.  It implies no improvement in H2.  This in turns means that Fed has over-corrected, and it can be in a position to raise its forecast in September when it could raise rates (as we expect).  

III

There are a few other economic reports that will draw attention, but are unlikely to have much market impact.  First, the eurozone flash composite PMI may slip for the third consecutive month. However, it is still largely matching the Q1 increase, suggesting the area is expanding around 0.3%-0.4% in Q2.  Second, eurozone money supply and credit is expected to continue to improve. Under the conditions of QE, repos fully allocated at a fixed rate, and TLTRO, it is not very surprising.  Third, the German IFO is expected to soften.  Given other survey data and the fall in the DAX, it is not so erosion in sentiment is not surprising.  

Japan issues reports on its labor market and inflation.  Like the US, UK, and Germany, Japan 's unemployment is approaching levels that economists expect wage pressure.  That was last week's story that helped sterling outperform. In Japan, there are some preliminary signs as well.  Japanese households appeared to wage a consumer strike in the face of last year's sales tax increase.  However, they are returning to the shops. The year-over-year pace of overall household spending is expected to turn positive for the first time since March 2014.  

The BOJ has already cautioned that CPI is likely to remain around zero for a few more months.  The May national figures may even show some slippage.  Tokyo's June figures should disabuse economists and government officials from thinking this is about to change.   Importantly, BOJ Governor Kuroda has succeeded in decoupling near-term underperformance of inflation from expanding QE.  

IV

Separately, HSBC reports its flash manufacturing PMI for China.  It appears that the stimulative measures are helping the economy stabilize at somewhat lower levels of activity.  China's stock market may swamp economic impulses after recording its worst week (Shanghai Composite fell 13%) since 2008. 

Trading in four hundred companies hit their daily loss limit before the weekend. Chinese stock have been a tear over the past year.  The median stock, according to Bloomberg, has a P/E of 95x. Aside from valuation issues, which has no appeared to deter buyers, the proximate triggers may include the more than two dozen IPOs that tied up CNY6.7 trillion and disappointment that the PBOC did not cut reserve requirements or provide as much liquidity as expected.  

The Shanghai Composite gapped lower before the weekend and closed on its lows, which makes another gap lower opening on Monday more likely.   The technical tone is vulnerable, and from this perspective another 5-10% near-term decline looks possible.  

The Japanese stock market is also at interesting crossroads.  Its eight-month uptrend was violated on a closing basis last Thursday and Friday.  However, here the technical tone is more constructive.  The Nikkei settled near its highs before the weekend, and technical indicators are supportive.  Recall the BOJ is buying stocks as part of its QE operations.  Pension funds continue to diversify away from JGBs and into stocks (and foreign assets).  As part of Abe's third arrow, the new emphasis on shareholder value facilities stock buyback schemes.  

The German DAX is trying to stabilize.  Last week it fell to its lowest level since February.  It has surrendered half of this year's gains.  That retracement level is found near 10,885.  Although on an intra-day basis the DAX has traded through there, it has not closed below.  A convincing break would suggest potential toward 10530 while a move above 11250 would begin improving the technical tone. 

The S&P 500 made recorded its best week since the end of April, rising 0.75%.  Even though it is poised to make new highs, it remains broadly sideways.  It is up 2.5% year-to-date.  The NASDAQ set new record highs before consolidating before the weekend.  It is up about 8% in the first half after last week's 1.3% rise.      At record levels, chart based resistance is meaningless.  However, provided that support is found in the 5040-5080 band, the technical tone will remain constructive.  

Source: Marc to Market
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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