Market Comment 15 February 2012

Markets have eased off this week, a move that was difficult to predict but is hardly a surprise as we are pushing at technical limits and continuing to wait for clarity on Greece.

The recent announcement that Greece voted through the budget cuts necessary to meet the conditions of the troika's rescue package has not led to a further up-move, and the market's caution has been reflected by politicians who continue to stall until Greece has honoured the minutiae of the agreement. (Concretely, we are still waiting for Greek political party leaders to sign up.) More importantly, the scale of political resistance on the ground is now so great that it is far from certain that the EU will ever feel sufficiently confident to release new money.

One possible solution will be to put the funds into an escrow account, from which they can be released as milestones are met. It is curious why such an approach was not used in the first place. Greece could have done far more to improve the competitiveness of its economy, notably if the EU had not simply accepted easier to make, but less structurally supportive budget cuts in return for rescue funds.

Other news remains mixed too. Moody's threat to downgrade the UK is unhelpful, and the data coming out of Japan are concerning, although the Bank of Japan’s decision to target inflation explicitly is good. Selling yen looks like an increasingly one-way trade now, we can only hope that the currency has not done irreparable damage to the economy. If Greece is an issue (GDP €220 bln), the last thing we need is Japan (GDP €5.3 tln) suffering a confidence break.

In the US, retail sales data for January were slightly below expectations, but this is not a huge surprise. The market had become accustomed to better than expected US data, and so upgraded its expectations. The FOMC projections warned that this typical binary risk-on/risk-off mentality was flawed. Sure enough, the data flowing now are not negative, but less aggressively positive. This is a long, slow economic cycle.

Markets remain highly dependent on the situation in Greece, although it is reassuring that the Chinese have backed the euro this week. It increasingly looks as if Europe has reached the end of its tether with Greece, and the global market increasingly believes that the system can sustain an uncontrolled default. The question is whether this threat is enough to motivate sufficient reform in Greece to secure the rescue package on the table, which is far from ideal, but for many people surely better than economic free-fall.

In the end, then, little has changed. If the terms are met the rescue will take place and the markets have the scope to rally. If not, we face the threat of volatility (although likely less than we experienced last year).

We continue to like corporate bond markets, and look to build further equity exposure on pull backs.