Most of the major equity indices ended the week in negative territory, against a backdrop of increased volatility in the bond market and the currency markets. The Euro strengthened significantly in the earlier part of the week as a resolution on Greece looked forthcoming, Eurozone inflation picked up and the ECB revised higher their 2015 forecast for Eurozone GDP growth. While much of these gains were relinquished as the Greek situation deteriorated, the Euro still finished the week up +1.37% against the US dollar. The German 10-year government bond yield hit a high of 0.97%.
The Greek government confirmed on Thursday that they would be delaying the repayment of €300 million owed to the IMF. The decision was taken after negotiations on reforms required by Greece’s creditors (our friends, the Troika!) deteriorated with failure of these talks now a distinct possibility. Instead of making the payment on Friday, the Greeks will instead bundle together a number of payments owed in June to a single payment at the end of the month – a move the IMF described as “unorthodox, but permissible”.
European equity markets were among the hardest hit last week, as the Euro moved higher against the US dollar. Surprisingly, Mario Draghi made little effort to talk the Euro down further at the press conference following the ECB’s monetary policy meeting. The FTSE Eurofirst 300 fell 2.69%, while the German DAX equity index dropped 1.90%, now down almost 10% from the peak reached in April.
In Asia, Japan’s Nikkei 225 fell slightly, while Chinese equities bucked the trend and continued their breath-taking ascent. After suffering a two day decline of 10% the previous week, the Shanghai Composite Index of mainland Chinese shares rose a whopping 8.92% last week. In the US, strong employment data weighed on equities Friday, seen to be supporting the case for rate hikes from the Fed this year. The major indices finished the week marginally lower, down for a second week in a row.
European bond yields spiked higher last week, with the German 10-Year yield hitting 0.97% on Thursday, before dropping back on Friday. Still, the yield finished up 36bps for the week, closing at 0.85%. While it is still a paltry yield for investors purchasing the bond and holding till maturity in 2025, it is a long way from the record low of 0.05% in mid-April. Perhaps the call by Citi for the German 10-year yield to fall to -0.05% will prove to be the inflection point in the ending of the government bond bubble.
As I have previously said, a rise in yields would be welcomed as part of a reflation of the Eurozone economy, but it is still early days to judge whether the Eurozone economy can avoid the deflation trap. So far though, the outlook appears to be brightening but a reversal in oil prices would set inflation data back again. However, the speed of these moves does raise concerns about the actual liquidity in bond markets, a risk that investors may not be able to fully quantify.
European equity markets have opened marginally lower following a mixed session in Asia overnight. The recent wobble in Chinese equities is now a distant memory, with the Shanghai Composite Index of mainland Chinese shares rising another 2.17%.
On the macro front this week, there are reports on industrial production and inflation from around the globe and we also have retail sales data from the US and China. Employment data from the UK on Wednesday will provide an update on the labour market, a key determinant of the Bank of England’s monetary policy. There are a raft of reports from Japan, including the final reading of second quarter GDP. The second estimate of first quarter GDP growth is published for the Eurozone on Tuesday, with the consensus estimate is for the Eurozone economy to post quarterly GDP growth of 0.4%, up from previous estimate of 0.3%.