Equities remain vulnerable as uncertainties remain

Equities and bond prices fell again on Tuesday, as capital markets remain cautious on Greece and unsure on the state of the US economy and the interest rate outlook. The latest euro area inflation report for the month of May was also released on Tuesday, the flash reading for the core inflation rate for the region rose to 0.9% year on year against expectations of 0.2%. The news of the sharper than expected rise in the inflation rate had surprisingly little impact on German bund yields.  German bund yields have risen from their lows of a month or so ago, but remain very close to historic lows. With year on year inflation now running at current levels this means that anyone who buys 10-year German bunds with a current yield of 0.57%, is in theory guaranteed to lose money! The uncertainty with regard to Greece does seem to have an impact on peripheral bond yields; Spain's 10-year bond yield has risen from a low of 1.25% to its present level of 1.9%.

Greece continues to dominate almost all the financial press; one gets the feeling as pressures mount ahead of the deadline for Greek's next repayment that we may be entering the end game. On Monday night Angela Merkel called an emergency meeting between the IMF, ECB and the EU for further discussions on how to resolve the crisis. Greek 2 year bonds currently yield approximately 24%, five year 16%, and 10 year 11%, the bond market is effectively pricing in a default.  In the likely event Greece does default on its debt, that in it is not a major event, Greece is now a small single digit percentage of the overall Gross National Product of the euro area. The concerns are for the wider implications, if Greece decides to reintroduce the Drachma, will the other peripheral countries look to put their own pressure on Germany? The outcome in our view remains that a solution will be found along the lines of 2012, this time hopefully a more permanent one. This will allow Greece to manage its debt burden, whilst at the same time remain within the euro.

The stronger than expected inflation data in Europe on Tuesday, may give analysts something to question Mario Draghi on other than the Greek question at the ECB press conference post the monthly rate decision. The ECB are committed to the bond buying program until September 2016, inflation picking up faster than economic growth could impact that decision, and analysts may well look to question Mario Draghi on that very issue.

Posted on June 2, 2015 .