Morning Report - Chinese stocks collapsing

Markets are higher this morning as Europe and Greece still try and to seek a solution. Bonds and MBS are up.

Greece and their creditors are basically searching for a way to finance Greece's next payment (about 3.5 billion euros) to the ECB which is due on July 20. If they default, the die is more or less cast. The final result of this negotiation will not be a bailout, but just a liquidity injection to keep things going for another month. The Greek banks have deferred tax assets and Greek government debt as their capital. They are cut off from global credit markets and have been closed to prevent a bank run. The banking system will have to be nationalized and the Greek government will have to issue some sort of scrip to pay people.

If it weren't for the Greek Crisis, everyone would be talking about what is going on in China. Their stock market is collapsing, with the Shanghai Composite B share index down 40% in a month.  The Chinese government has been pulling out all the stops to try and support the market - cutting interest rates, increasing liquidity, creating a stock fund to buy up stocks to support the market - and none of it has been working. The Shanghai Composite B-share index dropped another 9% last night as margin traders get liquidated. To stop the selling, the Chinese government has basically suspended trading in 26% of the stocks on the Chinese exchange. Of course this does nothing but delay the inevitable. Chart: Shanghai Composite (B-shares)

Between the Greek and Chinese situations, bonds should be heading higher. We are already seeing the German Bund rally, with the yield having dropped from just over 1% to 66 basis points over the past month. Relative value trades should work US Treasuries higher as well. US investors (and loan officers) should brace themselves for a bumpy ride as the situation in Greece is hardly settled, China is a falling knife, and the Fed is in rate hike mode. Global financial stress is bond bullish, while the Fed's posture is bond bearish. LOs, tell your borrowers they are playing with fire if they are floating. 

That said, I think the overall medium term effect of the stress will be to push rates lower on the flight to safety trade. A struggling China will try and use exports to stimulate their economy, which means the US will be importing deflation. The last thing the Fed will want to do in that situation is to raise rates. As an added bonus, you could see renewed buying in MBS as investors reach for government guaranteed yield. TBA spreads to Treasuries could narrow, which means that mortgage rates could fall as fast or faster than Treasury yields. IMO, the Treasury market has been fading the moves overseas and is behind the curve. 

Job openings hit 5.36 million in May, another record in the JOLTS Job Openings index. There definitely seems to be a mismatch between what employers want (someone with the wisdom of a 50 year old, the efficiency of a 40 year old, the drive of a 30 year old and the paycheck of a 20 year old) and what is actually available in the labor market.