Contagion risk not very high; see risk-off trade: Banque

Reema: Do you expect a protractive period of risk-off for equities?

A: What we have now is clearly a risk off trade. Of course, with the usual suspects benefitting the US dollar, the yen which in turn translates into lower Japanese equities. So, you have a risk off trade right now because what the markets do not like under any circumstances is uncertainty and we got plenty of it right now.

Anuj: The last time we had something like this, we saw the way European markets stumbled, but the Asian markets moved on, India included. Would you expect something similar over the next three or four days? Or do you think this time it could be a bit different?

A: It is probably going to be similar, but of course, you have to take into account sentiment. Again, if you have risk off trade, it affects every market, emerging markets, developed markets and so on and currencies of course, first and foremost. So, you have probably about the next 48 hours, quite a bit of volatility until we see what the next steps will be. Looks like the Greeks want to go back to the negotiating table. Finance Minister Varoufakis has resigned. He was a very polarising figure and maybe that is the first sign that Greece might be willing to compromise a little bit. On the European side, there is a lot of interest in keeping the Eurozone together. We have basically a political construct which it was from day one and so far the political will keep the Eurozone together has been there, has been very strong. And we still expect some kind of deal to be reached in the next few weeks. But, of course, in the long run, the solution for Greece will have to involve some kind of debt forgiveness which at the moment is certainly not being discussed, it is not on the table But maybe something that can be discussed in the next few months.

Reema: So Grexit is not currently your base case scenario?

A: It is not our base case scenario, of course it is a possibility. We attach about 40 percent to a Grexit which is quite high but, a no vote that we have seen, does not necessarily mean we have Grexit. The probability may have gone up a little bit, but what we also have to pay a remind s that the risk of contagion to the rest of the periphery of the European periphery is not nearly as severe as it was a few years ago. You can see this in the yield spreads between peripheral Europe and core Europe where they maybe increased by 20-30 basis points, but not by 300 basis points as we have seen a few years ago.

Anuj: We had our guest editor telling us yesterday that a Grexit may actually strengthen the euro, because the weak link would be out. Would you share that view?

A: I cannot rule it out. We have maximum uncertainty now and the Euro is around 110 and not going near par to the US dollar. We also think that if you look at it from the other side of the equation from the view point of the Fed, I cannot imagine that they want a much stronger dollar because that creates headwinds for the US economy as well. So, it may actually filter into the decision by the Fed when to raise interest rates. And if you have turmoil in Europe, there is a good chance that an interest rate hike may come later rather than sooner which would put some downward pressure on the dollar of course conversive with strength of the euro a little bit. But, you can make the argument that the euro without Greece could be stronger but, again there is so much volatility in between and so much uncertainty, it is hard to quantify this at this point.

Reema: You indicated that a deal is likely in the next few days. Will any deal be cheered by the equity markets irrespective of whether it is softer or harsher in terms of austerity for reforms or for aid?

A: You do not have a final solution here. We have to imagine with the position that Greece is in right now, if the banks closed, you have obviously the ECB can play God and they cut the liquidity assistance to Greek banks, that is something under consideration. There are so many ways this thing can play out. And do not forget that on July 20, Greece owes the ECB three and a half billion euros which they most certainly will default on and after that it is going to be very difficult for the ECB to maintain the liquidity assistance to the banks. So, honestly, once Greece runs out of cash, there is a lot of things that can play out.

Anuj: China, that has been a fascinating story. This morning of course, you had the index up eight percent and is now flat lining. Do you think there is a bit of a desperation from Chinese government and what is your own call on the Chinese equity market now?

A: In retrospect, when you had a bubble and this clearly has the same shape as the Nasdaq in 2000. In fact, even the extent of the drop is very similar, the initial drop. Now, obviously the Chinese government would like to put a floor on underneath and in fact this morning the market was up between seven and eight percent based n strength in a few very big blue chip stocks and obviously there was some intervention there to prop them up. But at the moment you have very negative sentiment. 80 percent of the A-share market in Shanghai is dominated by retail investors which makes it extremely volatile. You also have still very high margins debt and this is a mix which is very difficult to put a floor underneath even if you throw the kitchen sink at it, which the Chinese government has done. Not sure what they can do more from here, but margin debt will have to come down and this whole thing will have to play out so, it is possible that we may see a stabilisation in the next few days, but maybe with a bounce and a retest. That is usually how bubble play out. But it is impossible to see exactly which level it is.

Reema: You indicated that a deal is likely in the next few days. Will any deal be cheered by the equity markets irrespective of whether it is softer or harsher in terms of austerity for reforms or for aid?

A: You do not have a final solution here. We have to imagine with the position that Greece is in right now, if the banks closed, you have obviously the ECB can play God and they cut the liquidity assistance to Greek banks, that is something under consideration. There are so many ways this thing can play out. And do not forget that on July 20, Greece owes the ECB three and a half billion euros which they most certainly will default on and after that it is going to be very difficult for the ECB to maintain the iquidity assistance to the banks. So, honestly, once Greece runs out of cash, there is a lot of things that can play out.

Anuj: China, that has been a fascinating story. This morning of course, you had the index up eight percent and is now flat lining. Do you think there is a bit of a desperation from Chinese government and what is your own call on the Chinese equity market now?

A: In retrospect, when you had a bubble and this clearly has the same shape as the Nasdaq in 2000. In fact, even the extent of the drop is very similar, the initial drop. Now, obviously the Chinese government would like to put a floor on underneath and in fact this morning the market was up between seven and eight percent based n strength in a few very big blue chip stocks and obviously there was some intervention there to prop them up. But at the moment you have very negative sentiment. 80 percent of the A-share market in Shanghai is dominated by retail investors which makes it extremely volatile. You also have still very high margins debt and this is a mix which is very difficult to put a floor underneath even if you throw the kitchen sink at it, which the Chinese government has done. Not sure what they can do more from here, but margin debt will have to come down and this whole thing will have to play out so, it is possible that we may see a stabilisation in the next few days, but maybe with a bounce and a retest. That is usually how bubble play out. But it is impossible to see exactly which level it is.