All eyes are on Janet Yellen’s speech. Futures are in a waiting pattern, the Dollar is giving back some of its gains over the past few days and news is filled with what might be said. While this moment is going to have a significant play in the markets new found rate rise expectations for June, it is masking the longer dated but more significant events.
The talks in Greece about debt relief are old hat compared to the second rate hike in a decade for the US, but this time could be different in the nature of the bailout terms. In the past the unity of the troika would pit against Greece and come to the conclusion to kick the can down the road. This time one of the members of the troika, the IMF, is making demands for debt relief which Germany doesn’t want to look at (at least not until after 2018 elections).
This will work until the fall when the issue of debt relief will be brought up again by the IMF which is looking to have Greece’s debt ‘sustainable’ to continue to participate in the bailout. The exclusion of the IMF may not seem like a big issue but it will put more of the power into the hands of finance ministers like in Germany and add more of the fracturing political situation in Europe to the bailout talks. Without the IMF you could expect to see these debt negotiation that go to the brink before being resolved become a lot less certain.
Looking to the G7 summit for potentially market changing news is front and center on many analysts’ minds. The summit ending might be where the big news is going to come in. After the summit Japan will be out from under the direct scrutiny of other rich world countries and may look to add more stimulus to the economy by weakening the currency as well as delay the tax hike from 8% to 10%. This is going to be a large factor in the future because it will break down the fundamentals of the JGB market over time.
USDJPY Spot rate (Source: bloomberg.com)
There are three major points in the Japanese economy that must be overcome to have to robust economy and fiscally sound budget. One is the slow growth of the economy, which arguable is being addressed with the first and second arrow of Abenomics. The second is demographic which will no easily be addressed, and the third is structural changes to the economy.
The last point will require investors to have confidence in Japanese government bonds as a safe haven and store of wealth. With the removal of the tax increase another factor in the safe haven mix is being taken away. This puts the government in a weaker position as less and less pensioners buy JGBs (due to demographics) and more debt is required for the deficit and to cover higher interest rates. This will leave the BoJ with little choice but to continue to monetize debts, spurring more inflation, less confidence, and the cycle continues.
U.K inflation slowed in April which saw the pound pare back some of its gains against the dollar and Euro. Due to the fact that the majority of the price decreases came from clothing and air fare the numbers are not too alarming (unless you are a retailer or airline company). Later today the US will come out with its prior month inflation numbers which will be looked at with a bit more scrutiny as the US markets continue to assess the interest rate situation in the US.
The inflation portion of the Fed’s dual mandate seems to the place where wiggle room can be applied to the case for not raising rates as aggressively as the Fed projected. With the global headwinds we are seeing in Europe and Japan, and the debt worries in China there is no doubt that the Fed is looking for reasons not to start another round in tightening and sparking the volatility that came with it in December. In order for this to occur the Fed will need to see some softness in their mandates and inflation may be the best place to look for near term excuses.
Talks over the weekend about China and its debt crisis to loom large and is warranted. Many of the smaller undercapitalized banks would need (and are advertising) backing from the government in the event losses are incurred. This is not too far from what is going on in Greece at the moment.
With more funding needed by June to make debt payments, the Greek government has to show regulators that it is following through with reforms and terms of the bailout. This is causing anther game of chicken which will most likely end in the same fashion, a last minute deal. Where the concern should come in of that over the past few years the political landscape in the Eurozone has become less cohesive. Whether from the Migrant crisis or plain Euro-skepticism from austerity, the governments of the EU are going to make it harder for coordinated action. This doesn’t cause too many problems on its own, but does increase the risk of ‘mistakes’ in the way negotiations have worked in the past. As the games of chicken continue more leaders want to hold the wheel and might not all be pulling in the right direction at the right time.
Chinese regulators are forcing banks to provide provisions for loans that were sold as investment products. This is a win for transparency but could cause ripples in the markets as well. By stopping the flow of cash into these “investment products” from the wealth management arms of the banks will reveal how many of these loans values were based on the constant cash inflows from investors.
China’s increasing debt load has been used to generate growth in the past year. Without as easy of a flow of money, which is off balance sheet, the ability to continue the higher growth rate will wane. Longer term, China is relying on growth to shrink the percentage of non-performing loans, so by kicking them down the road in these ‘bad banks’ until they are less of a percentage of GDP will only work if GDP grows or the bad loans decrease. Since growth is now relying on risky loans to continue, a self-reinforcing cycle has been created, but the velocity is getting harder and harder to keep in motion. The stemming of off balance sheet debt just might be enough to pull this Chinese economy back to earth.