Turkey Rivals Greece For Sell-Off, FX Markets Choppy

The last time a horse won the Triple Crown was at the start of the first dollar rally after Bretton Woods collapsed. It has been 37 years and we think that dollar has begun its third rally since Nixon took the final step in breaking the link between gold and the dollar.

The strong US jobs data before the weekend has strengthened views that the Federal Reserve will get the opportunity it seeks to hike rates later this year. The dollar finished last week with strong momentum. There has been little follow-through today.

Partly this is due to the light economic calendar today, and partly the market responded to news wires' claims (apparently from a French official) that President Obama told the G7 summit that the strong dollar posed a problem. The White House officially denied the reports and the dollar recovered. While US officials have said the rise in the dollar is a headwind, the Federal Reserve clearly sees it as temporary. The pace of change may be more important from a macro-economic point of view, in some respects, than the level per se.

In its clarification, the White House not only denied the French statement, but reiterated the longstanding US position: the global economy suffers from weakness in aggregate demand and G7 countries should pursue more growth oriented policies, which include fiscal and monetary policies as well as structural reforms.

The dollar had been drifting lower against the yen, reaching JPY125.00. Japan reported a larger than expected upward revision in Q1 GDP. Owing largely to stronger capex (2.7% rather than 0.4%), Q1 GDP was revised to 1.0% (quarter-over-quarter) from 0.6%. This turns into a 3.9% annualized pace rather than 2.4%. Such growth is thought to argue against the need for more BOJ stimulus, though QE is aimed at fueling inflation.

Separately, Japan reported a smaller than expected April current account surplus (JPY1.326 trillion rather than JPY1.687 trillion). Within the report, Japan indicated that it had sold JPY1.33 trillion of German bonds and JPY905 bln French bonds. Japanese investors were small buyers of UK bonds (JPY150 bln), Italian bonds (JPY147 bln) and Belgian bonds (JPY115 bln). They were sellers of US bonds (JPY296 bln), and interestingly, Chinese bonds (JPY11 bln).

China reported a much larger than expected May trade surplus. It swelled to $59.49 bln from $34.13 bln in April. Exports were not as weak as expected but still fell 2.5% from a year ago. The Bloomberg consensus had expected a 4.4% decline after a 6.4% fall in April. However, the fall in imports was larger than expected. They fell by 17.6%, compared with the 10.0% decline expected. Imports fell 16.2% in April from a year ago.

The bigger story in China is the MSCI decision whether to include A shares in its emerging market indices. The decision is expected to be announced before the local markets open tomorrow. It is a close call. We suspect many of the larger asset managers are prepared, but many smaller and medium sized funds may not. It is expected that there would be a year long lead time between the announcement and the implementation.

The big surprise over the weekend was the Turkish elections. Many, like ourselves, thought the issue was whether Erdogan would secure a super-majority, which he would use to further lead Turkey away from its secular, pro-EU path and toward a religious state that would drift further away from western Europe. In the end, Erdogan's AKP failed to secure even a simply majority. The political uncertainty has spooked investors. The Turkey 10-Year bond yield is up 52 bp today to 9.57% and the equity market is off more than 6%. The Turkish lira has lost 4% against the US dollar.

Greek markets are mixed. The 10-Year bond yield is up 32 bp. The stock market is slightly positive. It is not clear where things stand, except that Greece has rejected the official creditors proposals to "extend and pretend" and the creditors have rejected Greece's proposals for debt relief. EU Parliament President Schulz warned that if Greece leaves the monetary union, it would also have to leave the EU. Such remarks do not seem particularly helpful even if true. Either monetary union is irreversible or not. Grexit talk from senior officials is counter-productive.

No one says that France, for example, which has repeatedly failed to deliver a budget deficit in line with the agreement made with the EU should decide whether of not to be in EMU. Europe needs to develop procedures and institutional capacity to allow a debt restructuring within the fold. In some ways, it has already. Both Greece and Cyprus have restructured debt to the private sector. The problem is that the the bulk of Greece debt is held by the very same officials who are regulators (ECB), other governments (EU) and the IMF.

The US reports the Fed's Labor Market Conditions Index, which is not a market mover. Canada reports (May) housing starts and April permits. These are not market movers either. The markets remain vulnerable to headline risk from the G7 meeting and Greek developments. We think the US dollar rally has resumed after correcting lower from mid-March to mid-May.