Renewed stress in Greece

FX

Ten-year Greek bond yields have risen sharply this week – around 250 bps so far – and the country’s stock market has plummeted. And all this at a time when Greece is supposed to be close to exiting its Eurozone/IMF rescue plan. Steve Barrow (our G10 FIC Strategist) has pointed out that this could prove to be the proverbial canary in the coalmine – as other periphery bond markets in the region are likely to follow suit. Steve notes that this weakness in periphery bonds has started to gather momentum and he thinks there’s much further to go. It won’t reach 2011/12 proportions, but it could still get ugly. French President Hollande admitted yesterday there are problems. He said that the Eurozone crisis is over but the economy is weak. But this seems to imply that weak growth does not constitute a crisis. Steve disagrees. Perennially weak growth in the Eurozone can create a crisis that’s every bit as big as the bond crisis we went through in 2010 and 2011. Steve has long argued that the real danger of an EMU breakup does not revolve around the sort of bond market strains we saw a few years ago, even if they seemed to push Greece very close to the edge. Instead, he views the danger as stemming from seemingly never-ending economic stagnation that leads to the rise of anti-euro parties in the region. Steve does not think that any member countries are yet close to the point of radical political change that could usher in a volte face on EMU membership. But, if growth remains dismal, deflation takes a bigger grip in many countries and unemployment stays at sky-high levels, it will surely only be a matter of time before one, or more, country drifts close to EMU’s edge. This possibility makes it crucial that the Eurozone starts to grow again, begins to see much lower unemployment, and moves away from deflation.

Comments by St. Louis Fed President Bullard grabbed the attention of markets overnight. Bullard expressed his concern that “inflation expectations are declining in the US” and that this might warrant “delay[ing] the end of the QE”. The FOMC has indicated that, as long as “incoming information” continues to support its expectation of continued progress towards its long-run objectives for the labour market and inflation, that it would “end its current program of asset purchases at its next meeting” - that is, the 28 to 29 October meeting. Bullard went even further, saying that “we could react with more QE if we wanted”. Bullard is currently not a voting member on the FOMC.

Yesterday’s release of strong US industrial production numbers allayed some of the concerns over the US recovery stoked by the Wednesday’s disappointing retail sales, Empire manufacturing and PPI data. Industrial production grew 1.0% m/m in September, a marked improvement on August’s downwardly revised -0.2% m/m (previously -0.1% m/m) and much stronger than the consensus call of 0.4% m/m. Capacity utilisation was also up, coming in at 79.3% from 78.7%. Analysts had expected 79.0%. Jobless claims numbers were generally encouraging, with initial claims for the week ended 11 October falling to 264k from 287k in the preceding week. And, although the Philly Fed regional manufacturing index fell in October to 20.7 (from 22.5), this was less than the expected fall to 19.8.

There is not much on the international front in terms of data today, although there are a number of central bank speakers. First up are ECB members Constancio and Weidmann. The former will talk about banking; the latter about reforms. Steve Barrow (our G10 FIC strategist) suggests that, with financial markets roiled and inflation expectations tumbling, the market might on the lookout for any signs that offer comfort - from Constancio in particular. Weidmann presumably won’t give any, stressing instead that reforms are necessary for economic wellbeing, not fiscal or monetary pump priming. Constancio talks on banking just ahead of the ECB’s assessment of major banks in the region (due out on 26 October). Clearly any bad news out of this assessment could hit Eurozone bank stocks at a time when they’ve already been under some pressure. Therefore, it will be worth listening out, in case Constancio gives any hints at all about the financial shape of the major banks.

Fed Chair Yellen also speaks today, but it is on the subject of “Inequality of Economic Opportunity” and hence Steve doubts that there’s going to be any mention of the economy and monetary policy. This being said, in light of recent market turmoil, he thinks that Yellen might want to convert any question into a comment on the current situation. Not surprisingly, we have already seen a number of regional Fed presidents comment on recent strains. As already mentioned, Bullard helped shake things up a bit yesterday. Yellen will likely be less controversial. Steve does not think that the Fed will delay the end of QE in the way Bullard suggests. Nonetheless, it might just make the Fed even more sensitive about wording changes in the post-FOMC statement later this month. For instance, it may be that the Fed will keep the reference to a “considerable time” (before rate rises), even if it has to drop its connection to the end of bond purchases.

Also today, Eurostat, which produces data for Europe, is due to present updated GDP numbers to reflect the new calculation methodology, termed ESA 2010. Among other things, these revisions will include research and development spending as an input into GDP calculations. The changeover is worldwide and other countries that have implemented this approach have, unsurprisingly, seen their GDP rise relative to the old definition. This should be the same for the Eurozone but, as Steve points out, it is important to remember that this does not necessarily mean the Eurozone is growing any faster and, as such, should (hopefully) be a non-event as far as financial markets are concerned.

The rand weakened against the US dollar yesterday for the third consecutive day, closing at USDZAR11.12 compared with Wednesday’s close of USDZAR11.07. Rand weakness against the greenback occurred into a mixed performance from the dollar against the major crosses, weakness across all of the commodity currencies we monitor for purposes of this report, and into a mostly weaker performance from the EM currencies we cover. The dollar strengthened against the euro and the yen, while weakening against the pound. The rand weakened against all of the major crosses, with the biggest move seen against the pound (0.8%). The rand took up the middle position in the commodity currencies category. All but two of the EM currencies we monitor for the purposes of this report depreciated on the day. The exceptions were the TRY and the THB, both of which appreciated. The rand traded between a low of USDZAR11.0594 and a high of USDZAR11.1976 intraday. Support from where the rand opened this morning sits at 11.0400, 10.9500, 10.9200 and 10.8000, 10.7500. Resistance levels sit at 11.1650, 11.2450, 11.3100, 11.3550 and 11.4000.

Commodity price moves were mostly weaker. Copper, platinum and gold fell by 1.3%, 1.2% and 0.3% respectively. Brent meanwhile rose by 0.8%. The developed market MSCI fell by 0.2% and the EM MSCI by 1.2%, while the ALSI rose by 0.4%. The EMBI spread compressed by 2 bps and SA’s 5yr CDS spread compressed by 1 bp. The CBOE VIX index, a volatility based proxy for global risk appetite/aversion, fell by 4.0%.

Non-residents were moderate net sellers of local equities (-ZAR418 million) and were aggressive net sellers of local bonds (-ZAR2 251 million) on the day. Selling of bonds was meanwhile seen in the 12+ (-ZAR1 735 million), 3-7 (-ZAR365 million) and 1-3 (-ZAR227 million) year segments. Buying was seen in the 7-12 (ZAR76 million) year bucket. Bond yields rose by between 13 bps (R203 and R208) and 14 bps (R186 and R214). The 3x6, 6x9 and 12x15 FRAs rose by 3 bps, 7 bps and 10 bps respectively.

FI

No major data comes out today, though there is an early afternoon speech by Fed Chair Janet Yellen on “Inequality of Economic Opportunity”. After two days of extreme market swings, today could see markets take a breather. Volatility in the currency market remains key though, affecting the direction and degree of moves in the FI market. At today’s ILB auction, NT is planning to raise up to ZAR800m across the R212, I2025 and I2038.

Another day of roiling markets, with SA FI certainly having a weaker bias and reversing much of Wednesday’s gains. In yesterday’s daily, we had said that “We have been suggesting trading the R186 in a 7.90% - 8.35% range over the past few weeks and we think the R186 could drift slightly higher from current levels”. However, we weren’t expecting the size of the weaker moves yesterday. The entire curve parallel shifted higher by 12.5 – 13.5 bps, with back-end bonds and the R186 widening the most. Turnover was slightly below ZAR21.2bn on the day, with the R186 accounting for 56.8% of turnover and the R214 accounting for 9.3% of turnover. Only 15.6% of turnover came from bonds with a shorter maturity than the R186. FRAs ticked higher, following bonds, with further out points moving 10 bps higher. Following two consecutive days of broad-based strengthening in US Treasuries, these notes sold off yesterday. At the short-end, the 2yr UST rose by 3.57 bps to a yield of 0.34% and the yield on the 5yr UST rose by 3.70 bps to 1.38%. At the longer-end, the 10yr note rose by 2.01 bps to a yield of 2.16% and the yield on the 30yr note rose by 1.77 bps to 2.94%.

Offshore investors effectively sold the amount they had bought on Wednesday, recorded as net sellers of –ZAR2.25bn of nominal SAGBs. This follows five consecutive trading days of net foreign buying. Net selling was recorded across the curve, with the 12+ year segment recording the largest outflows, totaling -ZAR1.74bn. This was mainly due to selling recorded in the R186 (-ZAR1.76bn), R2032 (-ZAR436m), R2030 (-ZAR111m), R2048 (-ZAR109m) and R213 (-ZAR106m); these outflows were partially offset by net buying recorded in the R214 (+ZAR504m), R209 (+ZAR159m) and R2044 (+ZAR133m) within this category. Foreigners sold -ZAR365m in the 3-7 year maturity category due to outflows recorded in the R208 (-ZAR225m) and R207 (-ZAR166m). -ZAR227m was sold in the 1-3 year segment, due primarily to outflows recorded in the R159 of -ZAR219m yesterday.

When we wrote our daily yesterday, we also said “all non-comp options are well in the money and we expect the full 50% to be taken up”. That was slightly premature, with the market moves soon taking the non-comp options out the money. The SARB website is reporting only ZAR558m was raised in non-comps. This represents only 24% of the total amount (ZAR2.35bn) raised on Tuesday, compared to the 50% of the auction that participants are allowed to take up. ZAR22m (3%) was raised in the R2032, ZAR215m (27%) was raised in the R2037 and ZAR321m (43%) was raised in the R2044 yesterday.

EM FI markets sold off yesterday in line with the selloff in US Treasuries. 5yr local currency sovereign yields rose by 8.87 bps on average and 10yr yields rose by 9.77 bps on average. SA’s FI market recorded a poor performance against its EM peers, with the 5yr and 10yr notes selling off on the day, both underperforming relative to the respective EM averages. SA’s 5yr yield rose by 10.30 bps behind weaker moves recorded in Turkey (+27.00 bps) and Hungary (+25.00 bps). SA’s 10yr yield rose by 11.90 bps behind weaker moves recorded in Hungary (+30.00 bps), Turkey (+20.00 bps) and Poland (+12.60 bps). In contrast India’s FI market strengthened on the day.

EM currencies also sold off on the day, with the Indian rupee leading the moves weaker. The rupee depreciated by 0.69% yesterday, followed by the Brazilian real, which depreciated by 0.61%. Other currencies to depreciate yesterday were the Polish zloty (0.43%), Russian ruble (0.42%), SA rand (0.39%), Indonesian rupiah (0.27%), Mexican peso (0.21%) and Hungarian forint (0.16%). In contrast, the Turkish lira appreciated by 0.30%, while the Thai baht appreciated by a marginal 0.03% on the day.

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