Feeling the heat

This headline certainly applies to me as I sit in Daniel Stewart's 'office' on the coast South of Rome, where it has felt like 40C ever since I arrived. More importantly, if I may be allowed to trot out one more time my  'Cat on a Hot Tin Roof' allusion, the heat in one form or the other is clearly also getting to investors as they fret how they can escape before everyone else, should this become necessary.

Chinese domestic equities have seen the biggest scrambles in recent weeks, now back up over 20% since their low point on July 9^th and the only major markets to record gains last week but, nevertheless, down overall in July with many companies' shares still suspended. Having being deliberately ramped up by the authorities these markets now need propping up. Although it is still not easy for foreigners to get involved directly in China A shares, developments there are having much wider impact with a rippling out to Hong Kong, Australia, many other Emerging Markets, commodities, mining companies (affecting the FTSE 100) and the dollar.

Chart 1 US equities weight of worries

Source: Daniel Stewart, Bloomberg

US equities retreated again last week, with even the go-go Nasdaq hit by mixed Q2 corporate earnings. The S & P 500 yet again failed to hold 2100 and is now only 1% up in 2015 while the DJIA is actually showing a loss. I do not normally refer to individual companies but Amazon's unexpectedly large and broad-based profits in Q2 prompted one cynic to admit that Hell had indeed been frozen over and published on Twiiter the picture below from Norway.

European equities also ended the week softer despite all the excitement of the previous week, not least because of the stronger euro, which in turn suggests that some investors are nervous enough about Greece and/or slowing global growth, to close out their riskier carry trades. A further negative signal came from falling sovereign bond yields but this time not only for German bunds (and other Northern issues) but across the board, reflecting confidence in the ECB and despite fears that Portugal may soon need further help. A dedicated Europhile might welcome on political grounds the convergence of price movements between EMU equity and bond markets but it does not make economic sense and seems unlikely to last if the negotiations with Greece run into further trouble.

Chart 2 European equities moving together for how long?

Source: Daniel Stewart, Bloomberg

Reducing expectations for growth and inflation seem to explain why both US Treasury and gilt yields fell, despite hawkish talk from FOMC and MPC members, with the opposite impact on gold and oil prices. On gold, I must pay tribute to my colleague, Austin McKelvie, for his bold call two weeks ago based on his analysis of the mining industry as well as acknowledging @smaulgld's argument that investors may be underestimating how much bullion is held throughout China and are in danger of confusing the futures market with the real yellow stuff. I might also permit myself a modest pat on the back for less bold forecasts on oil prices since their unsustainable speculative bounce in April. Nor am I deterred by all the posturing over the deal with the Iran. Why should the kleptocratic Iranian leaders trust the US all of a sudden after it has been trying to overthrow them for the last 36 years but we know they need the money and so the oil will surely flow? Similarly, US senators and representatives will surely be able somehow to finesse the powerful Jewish and Big Oil lobbies.

The hunt for yield has made many markets run hot for too long and now as sentiment turns negative there is a danger that too many investors still on the hunt will head for the same places at the same time, especially through shorting. There already widespread concerns over lack of liquidity in many markets where leverage is prevalent and where there are mismatches between asset and liability maturities. As the Tin Roof gets hotter the more cautious 'cats' already seem to be jumping off while they can.

Chart 3 Punters retreating on low growth and inflation expectations

Source: Daniel Stewart, Bloomberg

Eurointrigue

Too much has already been written on the subject of Grexit and so, skipping lightly over the details, I will confine myself to the following observations:

• The only financial deal done in the latest shenanigans is the pre-cycling of money from the EFSF bail-out fund to the IMF and ECB to avoid default. None of this money will end up in Greece. Another pre-cycling is likely to be necessary by August 20^th
• It is far from clear how much new money Greece actually needs but probably a lot more than the mooted €86bn, as the economy has been deteriorating since Syriza took over. The first members of the rumoured 100+ team from the EU/ECB/IMF troika are back in Athens now that the Greek parliament has passed the legislation comprising the preconditions necessary for the commencement of (fraught) negotiations and subsequent (even more fraught) monitoring.
• Although much bandied-about (and necessary) debt relief is unlikely to be discussed in earnest until early 2016 when the first serious progress reports on the new bail-out will be submitted by the troika.

More interesting perhaps is that the appropriately Greek mythical Pandora's Box really has been opened to expose the 'evils' of the EMU project and, indeed, the EU itself.  Nobody emerges with credit as revealed by the Dramatis Personae below.

Germany: Finance Minister Wolfgang Schäuble is cast by many outside Germany (reveling in their Schadenfreude) in the role of the pantomime-villain who tried to push out Greece. Two versions of why Grexit did not happen are, first, that the Germans knew Mr Tsipras had no choice but to capitulate or, second, that they were surprised when he did appear to accept their draconian demands. The second seems more plausible and on this basis the Germans are likely to try again but in any case will be unrelenting in their demands. There is talk of a power-struggle between Mr Schäuble and Mrs Merkel (cast by some as an unlikely Widow Twankey) but in reality they need each other to keep German taxpayers onside and to counter the plotting of their SPD coalition partners. Talk of a German exit from EMU is fanciful but the slogan 'More Europe' is sounding increasingly hollow and avoiding Brexit (next June?) from the EU must now be a priority.

France: under the guise of solidarity with Greece, Mr Hollande has adopted a high risk strategy in alliance with Germany's SPD and Italy's PD to neutralise or even better topple the Merkel-Schäuble axis. The immediate aim would be to postpone and/or water down the deficit and debt rules in the Stability and Growth Pact (SGP) while also encouraging the ECB to step up its QE programme (including hoovering up any new bonds issued to bail out Greece). The long-term goal also remains of building the EMU into a fiscal union and thereby a transfer union (from Germany). Bashing the 'Bosch' could play well in the 2017 election, always provided it works.

Italy: Prime Minister Renzi has already shown himself to be a bold tactician and his alliance with France is something of new departure but he too wants the SGP 3% annual deficit rule to be relaxed as he is planning to cut taxes. Moreover, with a Debt/GDP ratio of 130% he needs all the help he can get from QE and in the future common eurobonds. The flood of illegal immigrants is an increasing burden on Italy and represents at least one genuine area of solidarity with Greece. Unlike Mr Hollande Mr Renzi has no ambition to lead Europe but some concessions by the Northerners would help him against opposition parties, which all agree on Italexit from the EMU (albeit not much else) as well as internal PD rivals.

Other countries: for reasons of their own, only Cyprus (family ties) and Luxembourg (keeping the EMU gravy train) backed France and Italy in the fight against Germany. Interestingly, Spain and Portugal took a hard line but both governments face difficult elections later this year. The poorer Northern and Eastern countries understandably baulk at giving money to Greece with its higher income per capita and pension payouts. Others simply kept their heads down.

EU Commision/ECB were clearly collaborating if not conspiring with France to undermine the German hard line in order to avoid Grexit at any cost. Naturally enough they favour any progress towards more fiscal and political integration but it is not clear how far this would take them in support of relaxing the SGP or other economic reforms in Southern Europe. The ECB already has lost its claim to be politically independent while the EU Commission is fast alienating support in the North and East.

IMF: internal divisions continue to rage since the since disgraced Dominique Strauss-Kahn with covert US support agreed to get involved in a bail-out of a much wealthier country than most of its members. It is unlikely to recover soon much of its credibility and so getting its money back seems to be the priority. It remains a mystery whether EMU leaders have given some sort of oral indemnity (which they probably never expected to be called upon) but Christine Lagarde's latest tough talking suggests she is looking for something more concrete. It is probably the case that most of the Europeans on the IMF staff, including Ms Lagarde, would like to see less German domination of the EMU and have been happy to support the French/Italian/EUCom/ECB alliance, albeit discreetly.

US: in its paranoia about Russia under Putin, the US has been desperate to keep Greece in the Western camp and has used NATO to bully the Baltic countries who are struggling enough without having to support a richer Greece. The US is also aggrieved at Germany's limited direct contribution to NATO and feels justified in putting pressure on it to give money to Greece in lieu. Many telephone calls from Treasury secretary Lew may have encouraged the French-led alliance as well as the Greeks themselves.

Greece: the foot dragging has already begun with postponement of parliamentary approval of some of the preconditions and 'logistics' for the troika inspectors in Athens. Syriza leaders have hitherto shown themselves up for all manner of wheezes: after all, none of them believe in the proposed new bail-out beyond getting the money. The unknown for Mr Tsipras is to what extent the French-led alliance will support him when he fails to implement some of the legislation that he has forced through or fails to collaborate fully with the troika. It seems he may call an early election to strengthen his hand but in the end it is the guys with money that count and Mrs Merkel and Mr Schäuble have run out of patience.

Accordingly, with so much intrigue on all sides my money is still on Grexit sooner rather than later

On a less dark note, the chat below is taken from research by the Pew Research Center on national stereotyping which, despite my own mongrel descent, I sense I am guilty of too.

Economics: slower and slower

Economic forecasting is a mug's game even under the best of circumstances but the IMF have the additional hurdle of avoiding offence to prickly national governments which never like facts to get in the way of a good target. This usually means successive forecasts are reduced as they become more current. Sure enough, earlier this month the latest quarterly forecast for world output in 2015 was trimmed to 3.3%. The trouble is that none of the locomotive economies is pulling its own weight let alone anyone else's. Some like China and Germany even look like heading off to join Japan in a siding while some of once-vaunted BRICS are in danger of derailment. It seems that while lower oil prices are feeding through to lower inflation there has not yet been much of an offsetting boost to consumption and business investment.

US: It looks like the long wait for the first interest rate rise is about to end. In fact, it could in theory end on Wednesday at the close of the FOMC next meeting. There is a general assumption that any major decision will only be taken at the quarterly meetings at which participants turn up with their forecasts on growth, employment, inflation and future interest rate levels and after which there is a press conference during which the Fed Chair explains such a decision. The next such meeting is in September and Dr Yellen and others have dropped hints that seem less teasing than of late. However, Dr Yellen has also said she can put up rates whenever she judges it necessary. The irony is that on purely economic grounds a hike still does not look necessary. The Labour market is much improved but far from sorted as evidenced by a historically low Participation Rate and tepid growth in average wages. Industrial Production and Retail Sales have both had a run of soft months and, despite all the special pleading in respect of Q1, full year GDP in 2015 will struggle to reach growth of 2.5%. Certainly, there are no inflationary pressures to worry about as can be seen from the next chart. So, why might the FOMC move in the next few months? The cynical response is to justify both itself and the mammoth increases to the Fed balance sheet by declaring the end of the crisis that began in 2008 before it becomes more evident that the only genuine success was providing liquidity at the critical moments. There is definitely some truth in that explanation but it also seems clear that the Committee is increasingly (and surely rightly) worried about the effect of zero interest rates on borrowing and investment decisions by individuals, companies and institutions. It seems at least half the market is ready for the first increase while not expecting many more in total. My guess is still that Dr Yellen will want to take longer to let everyone catch on and that she does not raise rates until December.

UK: The MPC seems determined to delay its first rate rise until the FOMC makes the first move but, in fact, it has got more reasons to take away the proverbial punch bowl: GDP growth is at last back to its historical trend, average earnings have taken off, happy consumers are out spending and business investment is perking up. So why the delay? Like Dr Yellen, Governor Carney wants everyone to be prepared for the first increase soon but also reassured that rates will still be at historically low levels. Unlike her, he does not have to start from zero nor does he have a gigantic QE albatross hanging around his neck. The signalling process will be helped by up to 3 MPC members' intending to start voting soon for an increase, which is just as well in view of Mr Carney's own faux pas last year. The real reason for delay is almost certainly the likely impact on the pound, which is already too strong for comfort, especially against the euro, but even here the UK'a Achillies Heel of the Current Account should keep sterling capped. If the economy continues to make solid progress the MPC will no doubt press the button early in 2016.

Chart 4 Pound challenge for MPC

Source: Daniel Stewart, Bloomberg

EMU: the best thing that can be said is that things are no longer getting worse but with so much unemployment and so many gloomy consumers GDP growth of 1.5% is about as good as it can get. Even German consumers who are the happiest in Europe have not been doing much actual spending. The brightest spots have been Spain, Netherlands and Poland but even they are showings signs of peaking. The latest flash PMI reports from Germany and France were all lower in July. Pressure is mounting on governments for both tax cuts and more public spending. The chart below shows how the citizens of various EMU countries have fared since disaster struck in 2008. The unhappy story is set to continue Europeans have to get used to paying themselves less, retiring later and suffering cuts in public services.

China: the current blatant rigging of the stock markets and the surge in borrowing are casting new doubts on both the competence and truthfulness of the authorities. It is best to discount most of the latest data batch, especially Q2 GDP growth which was officially reported bang on target at 7% (annualised) but is widely thought to have been closer to 5% or even lower. Perhaps the least unreliable data comes in the PMI reports from Caixin/Markit (formerly HSBC/Markit): Manufacturing has been in contractionary territory for the last several months and now Services is starting to wobble. Another indicator is the global shipping unit price index prepared in the Netherlands, which has plunged by 14% in the year to May 2015 and by 20% since it peaked in March 2011. Excess capacity on this scale reflects the slowdown in global trade and helps to explain why China (the world's biggest trader) and the other locomotive economies are struggling,

Coming up this week

The FOMC just about merits top billing as a rate rise now or even just more strong hints about September would unsettle markets everywhere. Greece may get back on the radar screen if the government continues to play silly games.

The first cuts of Q2 GDP growth are due from the US, UK and Spain and although they could well turn out to be the best of the bunch they will probably raise new doubt on sustainability. A complication in the UK is the ONS's latest difficulty in collecting reliable data on manufacturing, especially in the first cut. Retail Sales in Japan, Spain and Germany may be flattered by comparison with last month's numbers.  The wrangling with Greece and now France are likely to have dampened both business (IFO survey) and consumer (Gfk) confidence in Germany.

The cats on the Hot Tin Roof may get jumpier or, better still, jump off on holiday!