Negative News Flow Sours Sentiment

BBH CurrencyView

• Dollar is broadly stronger amid concerns over Greek debt rating, China tightening; stocks mixed
• S&P warns plan for Greece is likely default; ECB to accept collateral unless all agencies rule default
• RBA on hold, Riksbank hikes by 25bps; Moody’s finds hole in China’s local government debt

The dollar is broadly stronger while global equities are mixed following continued uncertainty over Greek debt rating, a dovish statement by the RBA and concerns about China tightening. The euro gave back yesterday’s gains to trade down to $1.446 despite the ECB defense of the French rollover plan. Indeed, euro zone peripheral spreads remained wide and there was increased investor appetite to sell EUR/CHF, which underlined safe haven interest. Euro zone data releases were soft, with services PMI revised down and retail sales moderating from last month. Economic data, however, underpinned sterling’s advance as the rebound in June service PMI boosted sterling through $1.61. Stocks were mixed as Asian stocks wobbled amid reports China could raise rates this weekend, although the Euro Stoxx 600 extended gains to a one-month high, up 0.3%. Elsewhere, the Riksbank hiked by 25bps.

S&P warns debt roll over plans for Greece likely constitute default. French banks, with the biggest exposure to Greece, worked out a proposal that includes debt rollovers. It has been seen as a blue print for agreements elsewhere, but if classed as a credit event it could throw a spanner in the works as the ECB has warned against anything that could be classed as default and make it impossible for the ECB to accept Greek debt as collateral. Although, the ECB, who has been openly critical of the power that rating agencies maintain at this phase of the crisis, shot back as news report surfaced that the ECB will continue to accept Greek debt as collateral for loans as long as at least one of the three major agencies does not put Greece into selective default. In our view, the ECB’s willingness to compromise on the acceptance of collateral is likely is sign that it views the French proposal as one with the best chance of success yet we suspect that a full agreement might not be reached until September. Nonetheless, with the market unwinding roughly $3bln speculative euro contracts over the past two weeks and ahead of this week’s ECB meeting and US NFP we continue to expect the euro to target the $1.475 level over near-term. Thus, we would view any short-term consolidation as an opportunity to reposition for strength with support expected near $1.440.

In the central bank space two G10 central banks met with opposing outcomes and different views of their economic backdrop. The Riksbank hiked the key repo rate by 0.25% points to 2.0% the seventh hike this cycle in a bid to curb inflation. And while the rate hike had been widely anticipated, the decision was not unanimous as two of the six Executive Board members voted for no change. Of note was the cut in next year’s growth forecast, which was revised down to 2.2%. We nevertheless continue to expect two more hikes from the Riksbank this year off the back of rising inflation expectations. Alternatively, The RBA left rates unchanged at 4.75% but the Governor’s statement had a slightly dovish spin, noting that growth in employment has moderated over recent months while most leading indicators were suggesting that the slower pace of employment growth is likely to continue for now. The RBA continued to note that wage growth has risen, while underlying inflation will gradually rise and at the same time in its statement it retained the last sentence about assessing carefully the evolving outlook at future meetings. We continue to think that the market’s expectation of a rate this year are overly optimistic and expect the RBA to remain on hold for the remainder of the year, with the potential for a hike in late Q4 if the global economy emerges soon from its recent soft patch.

Moody’s comments today on the Chinese banking sector add to a chorus of voices highlighting the risks to the country’s economic stability. The agency stated that the numbers behind bank loans to local governments may have been underestimated. In addition, there were more rumors about imminent rate hikes by the PBoC. Indeed, yesterday the PBOC released the minutes for the Q2 monetary policy meeting. The statement was similar to that of Q1, emphasizing inflation as the primary concern. But local press articles suggest that the minutes did highlight the tightness in the intra-bank market and lack of funding to small businesses as a competing concern. Still, Chinese equity markets were stable overnight, though financial sector stocks were the clear underperformer in the Shanghai index.