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Daily Agenda: Slump on Chinese Markets Goes into Second Day

Gazprom announces pipeline partnership with Shell; Bank of Japan to sustain pace of easing; Royal Bank of Scotland to remedy retail banking errors.

High single-digit declines dogged major Chinese equity indexes for the second consecutive day, with the Shanghai Composite index closed down by more than 6 percent for the session. The primary Shanghai index is now down over 13 percent for the week, the largest drop on record for the benchmark. So far, the swoon in China has not lead to global contagion as underscored by yesterday’s strong debut for Fitbit, whose share price rose by close to 50 percent after holding an initial public offering in the U.S. yesterday.

Gazprom announces new Baltic pipelines. Yesterday Russian oil and gas company Gazprom, the world’s largest producer of natural gas, announced a plan to construct two new pipelines under the Baltic Sea in partnership with Royal Dutch Shell. The move, which will give a major boost to Northern European delivery capacity, comes at a time when joint investments with Russian energy firms is relatively rare due to Western sanctions and the correction in energy commodity prices that started in mid-2014.

Royal Bank of Scotland to resolve failed payments. The Royal Bank of Scotland announced today that no clients of its London–based retail and commercial banking subsidiary NatWest would remain out of pocket for any penalties or fees related to more than 600,000 failed transfers earlier this week. The bank has not publicly indicated the cause of the failure.

Time is nearly up for Greece. With less than two weeks before the combined payments to the International Monetary Fund for the month are due, the end is now in sight for Greece with default rather than a negotiated resolution as the increasingly likely conclusion. Media reports drawn largely from unnamed sources indicate that the European Central Bank is scrambling to insulate the Continent’s banking system from volatility in the event of a departure. Analysts at multiple banks have suggested that capital controls from Athens are imminent.

Bank of Japan to continue easing. In a widely anticipated move, the Bank of Japan today announced no change to its annual 80 trillion yen ($650 billion) quantitative easing program. Mixed signals of improvement in the underlying economic fundamentals have lead to a slightly hawkish tone in comments from leaders of the central bank in recent months.

Portfolio Perspective: Limited ContagionAjay Rajadhyaksha, Barclays

Limited contagion from Greece has finally hit European Government Bond (EGB) spreads. Worsening rhetoric between Greece and creditors against a backdrop of a need for urgent progress has finally pushed the market to price in more contagion risk across EGBs.

Since last Friday, ten-year Italian and Spanish spreads have widened about 40 basis points to reach 170 basis points intraday on Wednesday, before retracing back to 145 basis points at the time of writing. This has been the first occasion in a while that the sensitivity to Greece has increased in a more notable way. Indeed, the widening has been eye-catching in core/semi-core countries, with France and Belgium ten-year spreads also widening a remarkable ten basis points before reversing some of this later in the week. The other important sign of contagion has been the increased sensitivity of front-end periphery spreads during the widening. For a long time, core periphery spread term structure movements have been very directional to the ten-year point, such as ten-year Italian and Spanish spreads outperforming their front-end spreads during tightening episodes and vice versa. During the past week’s widening, however, front-end periphery spreads have widened as much as the ten-year point.

It is important to note that, based on anecdotal evidence the past week’s volatility and spread widening in periphery has occurred again in a very thin liquidity environment, without much actual cash selling. We are still of the view that a full-scale contagion from Greece to other EGB markets similar to that seen in 2011–’12 is unlikely. We have previously argued that if a short-term adverse scenario materializes in Greece, ten-year Italian and Spanish spreads are likely to widen to their fair value levels without any quantitative easing premium, which we predict to be 190–200 basis points.

Ajay Rajadhyaksha is a fixed-income strategist for Barclays in New York.

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