I Will Be Back: The Greek Crisis Redux Version

Here from Kathimerini

SYRIZA’s central committee is due to hold an emergency meeting Thursday in an attempt to find a way to settle the growing rift within the party over whether the government should agree to a third bailout or not.

In Pictures: Greece Referendum

Greece has a highly concentrated populations, majorly around the Attica region

Which is reflected in the highly concentrated economies as well

These figures are relevant, as most of the upside and downside will be concentrated, no matter how the Greeks vote today. Most opinion polls are also around Athens so far (including this one from Bloomberg). Based on the last elections and the parties that are campaigning for "No" vote, here is the "No" vote share for each region.

Finally, given the perception that the young population more likely to vote "No", here is the population pyramid (from here). The old outnumber the young.

Brace for some rough rides.

European Debt Crisis Redux: The Monday After

Here is how the world market reacted on Monday to the recent development in Greece

 

 

 

It is risk-off but to a moderate degree. As expected, Portugal has been hammered the most.

 

From now on, it is a question of how the politics play out till coming Sunday. Most probably most European institutions and political leaders will frame the referendum question as a in or out options for Greece. If the Greeks vote for a YES, that will probably lead to a topple for the current government, followed by a hasty coalition to pass through the extension deal, and perhaps an election later on. This is the central scenario. If the vote is NO then brace for the real stuff. According to media reports, a considerable portion of the Greek people are yet to reconcile the fact the staying in the Euro Zone and rejecting the current package is mutually exclusive. How the vote will turn out will depend on this starting numbers, and more crucially 1) how the Greek government pose the referendum question to their people and 2) The reaction of the core politics towards this over rest of this week.

 

And as usual, Euro is acting quite opposite to general expectation.

European Debt Crisis Redux, (And Other Things)

Very recent news flows has not been very positive from the Greek Bailout negotiations.

 

In this context, it is interesting to re-run the kind of analysis every one had tattooed on their forehead back in 2010 and again in 2012. Sovereign debt ownership, focusing on the southern block.

 

Portuguese bonds market ownership is quite dominated by foreign players. According to Bloomberg, banks and insurance companies own around 16% of total outstanding, of which around 13% is foreign owned. Another approx 7.5% belongs to the asset managers, which is mostly foreign. So total approximately 20% owned by foreign players, who can become jittery in case of an unexpected outcome in Greece. For Italy, total banks and insurance own 25% of outstanding, but only 7% foreign owned. Another 6% spread among asset managers without much concentration. Similar figures for Spain is around 8% for banks and insurance, and another 2% from asset managers, so around 10%.

Portugal GDP is not in the momentum we see in Spain (not even Italy). On the other hand, unemployment is far better and both have elections coming up this year. Incidentally we have seen a lot of spread tightening in Portugal bonds compared to both Italy and Spain since middle of this month.

 

Definitely something to watch out for.

 

Separately, the data flows from UK on the other hand has been solid lately. An august hike? Not likely, but BoE cannot trail the Fed for long. We have a slight re-pricing of Fed hike towards Mar 16, and BoE is priced in around Jun 16. Fair, possible. But what is surprising is the spread of the real rates. Historically the US and UK inflation spread has been on an average 0bps since 90s till before the Crisis, and 120bps for last few years. Sure Euro area can be a drag, but while US real rate is now around zero, UK is still firmly negative, around -65bps in 10y (taking differences of the nominal swap rates and the breakeven inflation swap rates). Markets prices US inflation much higher than UK. Although both shows strong labor market (perhaps UK with a stronger momentum). Expect a correction. Especially if you believe in the Euro area turning corner.

This is NOT Nuts, Where is the Crash? (II)

With dollar index on record highs, emerging market equities (except, of course, China!) getting bullied around on fed hike scare, and as the Greek saga continues, investors around the world are beginning to worry about risk trades. Especially equities and high yields. IF I am not mistaken, the latest Bloomberg investors survey points to that direction. Well, it seems we need not worry, not as yet! The Risk-On is going still very much strong.

I take the major equity indices around the world along with treasuries and internal sovereign ETFs (iShares) as well as high yields, and run some PCAs. The correlations as below.

The first one is obviously the risk-off/ risk-on factor. The second one is more like a fixed income allocation factor. The last one is domestic (US) vs international factor. We pick up the first factor and run it through a regime switch model (a Hidden Markov Model). The results below. The figure shows S&P Performance (orange) vs. the probabilities of different states we may be in. State 3 (bottom-most in black) represent Risk-On, state 2 (middle in black) is the Risk-Off state, and state 1 (top most in black) can be construed as Risk-Moderation state for lack of better words. As we can see, we are very much in Risk-On (click image for bigger picture).

Given the general nature of flows, esp smart money flows, chasing asset price momentum, we can say that much touted crash/ correction is a bit further away in to the future. Interestingly, similar analysis for other factors along with the assumption above means, for domestic investors, US fixed income is becoming increasingly less attractive, and foreign FIs more so.

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1. if you are wondering about the title, part I is here)

2. data from 2010 onward, analysis and plots by depmixS4 and Quantmod package on R 

Contrarian: Short EUR to hedge Grexit! Are You Sure?

Sounds rhetorical indeed. But does it? 

Two charts below on EUR/USD vs Italy benchmark 10y yield below. The first one shows YTD move, the second shows the relationship back in 2011-12, during the height of European debt crisis. 

It is true the general yield compression and euro sell off is driven by the same force, i.e. QE. However that does not explain the sustained correlation on the other side as well, i.e. periphery sell off along with euro rally. 

This puts a question-mark to the theory that a Grexit will result in a large euro sell off. It depends what safe assets you buy when you panic. But whatever it is, we will see a large move for sure.