The Americans and their allies were moving to reduce the intensity of air strikes in Libya now that the Colonel`s defenses have been mauled, and optimism with respect to Japan`s fortunes in dealing with the nuclear crisis was improving as well, but ironically markets have reacted to the news with sales today. Technical analysis experts, including Laszlo Birinyi, were predicting a fall of around 10% for the entire correction, but even if that were to happen, it will still be a brief reversal in what is essentially an central bank inflated global asset market.
Today`s sales were attributed to the 90-odd bps rise in Irish 2-yr yields, and since Asian markets were doing reasonably well with Japan in a bullish mood after yesterday`s holiday, this explanation seems to make sense. And if we consider how resilient the market has been to what could have been a period of severe pummeling, after a number of massive negative surprises, a little bit of selling should come as no surprise. We believe that stock and commodity markets will continue to remain in a bullish trend for as long as the Fed maintains its easing bias. As such, while the oil shock and the Japanese earthquake are powerful enough to derail any trend in the short-term, the printing press will rule in the longer term.
The main question is whether the Fed will be inclined to raise interest rates at any point as a consequence of the events that we are focusing on at the moment, in part due to emotional reasons. There is little sign that the bank will see the recent fluctuations as an indication of a shift in long-term, multi-year inflation expectations, on the notion that the Libya War as well as the Japanese Earthquake are all one-time events that will not have lasting influence on pricing power or consumption trends. To reinforce this viewpoint, we have some signs that the Japanese people will be even more conservative in their spending habits - a phenomenon that might at best be compensated for by increased government expenditure. Only a sustained bull market in the country would challenge this analysis, but Japan has no grounds to fuel such a trend, outside of the external dynamics generated by global economic growth. It therefore makes sense to expect both the BoJ and the Fed to maintain their present postures.
It is clear that the Asian and Western markets cannot remain decoupled from each other for a long period of time, and if the concerns about Europe intensify there is a good chance that we could see the weakness spread around the world to last till the end of this week. But given how big the incentive is for Europe to avert a breakdown of the E.U., after so much money spent and committed in the past year alone, we believe that the first half of 2011 will be a bullish phase, overall, for the world of finance.
The main focus of the markets remains being the Japanese nuclear issue in Asia, and the Portuguese debt problem and the Libya War in the West. Portugal`s yields are already at unsustainable levels, and there is talk of the President forming a caretaker government to pass a new budget, with the purpose of implementing austerity rules and reinforcing confidence to allow a refinancing of the June redemptions. We doubt that the President will choose this path, since the budget is a major point of contention in the political field, and an aggressive stance may well lead to a backlash from the new parliament, which could potentially complicate an already difficult situation.
Meanwhile, representatives of 40 nations from the E.U., the Arab League and NATO will be meeting in London today to discuss the future of the operations against the Libyan regime. Today news reports speak of the Colonel`s forces defeating and pushing back the rebel army from some of the coastal cities that they had gained on Sunday, but there is no sign of the initiative changing hands as the bombing campaign goes on. Statements from the U.S. side have detailed plans to use low-flying attack planes in ground attacks against the Libyan Army, and it is clear that pressure will be kept up. On the domestic front, a recent poll has shown that support for the Libyan campaign among U.S. Citizens does not exceed 48%, which is the lowest level of support for a military operation at its inception so far, and does not bode well for the president`s popularity if results are not obtained soon. If the campaign ends prematurely, oil prices could naturally see a significant correction.
In Asia, reports of higher-than-natural radiation levels have been emerging across a wide region. USA, Vietnam, Korea, and China have discovered radioactive particles in the air, but the authorities insist that the level of detection remains very low, posing no significant hazard to public health for now. The death toll in Japan has reached over 10,000 as 17,000 people remain missing, while cooling efforts at the reactors continue in spite of very high radiation readings. The latest reported leak of plutonium has compelled the government to publicly discuss plans to temporarily nationalize TEPCO, on the back of complaints that the company has not been responsible and effective enough in battling the crisis. The PM Naoto Kan has described the situation in Fukushima as "unpredictable", while Yukio Edano has characterized the same as being "very grave".
Interestingly enough, the FX market is somewhat more optimistic today than the stock market, which is performing rather poorly on a global scale. The USD is lower against most peers, but up with respect to USD JPY, which is usually a sign of improved optimism. On the other hand, gold and oil are both lower, but the downtrend does not show a lot of signs of conviction, and could reverse rapidly and easily if the factors that dampen global sentiment once again dominate news reports.
Weekly jobless claims data is out as usual today, and the 36,000 strong fall from last week`s revised number has been taken with great excitement and optimism by the commentators, although the U.S. Market has not been very aggressive yet in its response, perhaps waiting for the NFP release. The idea is that we are really seeing the beginning of the end for the rise of unemployment, with the Fed`s stimulus finally working to generate some self-sustaining momentum in the private sector. Yet the number seems like a little abnormality, a spike that doesn`t seem to be strongly correlated with the improvement in the 4-week average which is still holding firmly above the 400, 000 level.
Regardless of the immediate outlook for the labor market though, it is hard to see how much worse the numbers can get because the wider measures of unemployment that factor in those who are not counted in the headline number are already deep in the double digits, and it does appear like by and large the large froth in the market has been eliminated since 2005. That doesn`t mean that employment figures will allow us a sharp and sudden improvement any time soon, and as Bernanke says, recovery is likely to be slow and protracted. But it does look like the U.S. has had it share of labor market troubles – it is now the turn of others, especially those in emerging markets who have not at all been punished for their role in the bubbles of the past decade. They go on as they did before the crisis, and that for us means that they are still waiting for their part of the pain when the market finally decides to deflate their bubbles. They may have some time before it happens, but at least the U.S. is not the focus when the crisis arrives.
We also note the strange rise in the yield of Portugal`s five and ten year debt, even as the market remains in a bullish mood. The speculation is that the Portuguese government has been reaching out to more aggressive segments of the market in order to sell its junk, preferring the shorter-term at possibly lower yields. It seems that this attempt is failing as the fast speculators seem to be buying goverment debt only to sell it shortly afterwards for quick profits, increasing supply at a time when there are no obvious buyers. It is a sign of the times that the government is looking for saviors among the wolves and jackals of the hedge fund world and its various arms (or maybe tentacles?).
Up until the release of today`s jobless claims data, markets were in a weak mood, arguably because they have been so bullish over the past weeks that they need to take a break and refresh before taking the next leg higher. There is no shortage of reasons for worry, but traders are for now willing to take the risks as long as the general sentiment remains upbeat.
Market sentiment was dampened yesterday by today`s large debt auctions in the Eurozone, where the weaker members of the union will be borrowing at least $43 billion. Credit default swaps rose on Ireland, Belgium, Portugal, and while the CDS index that measures that default risk of Western European governments rose to match a record yield of 228 bps. There is a strong sense of tension all around the world as the results of these events approach.
Stocks were lower in response, and in Asia, Indonesia and India were the biggest losers. India`s not being treated very kindly nowadays after the scandals that shook the country a short while ago, while Indonesia is suffering from a worrisome inflation trend in line with the rest of the region. In Europe, naturally, the falls were sharper, while U.S. markets performed reasonably well in spite of the tense atmosphere.
The dollar, naturally, gained against almost all of its peers, while oil rose on anticipation that Asian demand will remain strong. We are pessimistic on oil in the near term, and expect it to reverse course if the European problems intensify, or the Chinese aggressively continue with their rate rises. Commodities are likely to gain to some extent this year as the Fed continues its easy money policies, but perhaps the first half will not be as rosy as some seem to be expect. Gold, meanwhile, should stay on its upward track, notwithstanding the severity of its up and down swings as volatility remains high.
Today`s events are obviously of great significance. What we expect is that, while auctions will find sufficient buyers, in line with the trend of the months, rates will be higher, and money will be supplied at a high price. Regardless of the result, markets are unlikely to be convinced one way or the other, since lacklustre demand is unlikely to signify a withdrawal of borrowers, and a strong showing doesn`t imply much for the future. This makes sense, because the debt issues are long term and will not be settled by one or two auction`s results. If Ireland is shunned by creditors, however, we suspect that it will only trigger stronger European intervention, and not capitulation, as some commentators seem to expect. It is hard to see, as we like to emphasize, how they can reverse course after committing so much to the economic and political integration of the continent. And while perhaps dropping some aspect of the European Monetary Union doesn`t signify a lot from a pragmatic viewpoint, the same cannot be explained to voters in the region. All that convinces us that European politicans will only capitulate when they are absolutely out of options, but with the Fed allied to them on the other side of the ocean it is hard to see how that even sort of situation would develop.
In summary we don`t expect much to happen as long the present governments remain in place. But we still believe that the Eurozone will disintegrate at some point in some way, only with the additional qualification that this development will be the consequence of powerful political events, and not some predictable surrender to speculators and the markets.
Market sentiment was dampened yesterday by today`s large debt auctions in the Eurozone, where the weaker members of the union will be borrowing at least $43 billion. Credit default swaps rose on Ireland, Belgium, Portugal, and while the CDS index that measures that default risk of Western European governments rose to match a record yield of 228 bps. There is a strong sense of tension all around the world as the results of these events approach.
Stocks were lower in response, and in Asia, Indonesia and India were the biggest losers. India`s not being treated very kindly nowadays after the scandals that shook the country a short while ago, while Indonesia is suffering from a worrisome inflation trend in line with the rest of the region. In Europe, naturally, the falls were sharper, while U.S. markets performed reasonably well in spite of the tense atmosphere.
The dollar, naturally, gained against almost all of its peers, while oil rose on anticipation that Asian demand will remain strong. We are pessimistic on oil in the near term, and expect it to reverse course if the European problems intensify, or the Chinese aggressively continue with their rate rises. Commodities are likely to gain to some extent this year as the Fed continues its easy money policies, but perhaps the first half will not be as rosy as some seem to be expect. Gold, meanwhile, should stay on its upward track, notwithstanding the severity of its up and down swings as volatility remains high.
Today`s events are obviously of great significance. What we expect is that, while auctions will find sufficient buyers, in line with the trend of the months, rates will be higher, and money will be supplied at a high price. Regardless of the result, markets are unlikely to be convinced one way or the other, since lacklustre demand is unlikely to signify a withdrawal of borrowers, and a strong showing doesn`t imply much for the future. This makes sense, because the debt issues are long term and will not be settled by one or two auction`s results. If Ireland is shunned by creditors, however, we suspect that it will only trigger stronger European intervention, and not capitulation, as some commentators seem to expect. It is hard to see, as we like to emphasize, how they can reverse course after committing so much to the economic and political integration of the continent. And while perhaps dropping some aspect of the European Monetary Union doesn`t signify a lot from a pragmatic viewpoint, the same cannot be explained to voters in the region. All that convinces us that European politicans will only capitulate when they are absolutely out of options, but with the Fed allied to them on the other side of the ocean it is hard to see how that even sort of situation would develop.
In summary we don`t expect much to happen as long the present governments remain in place. But we still believe that the Eurozone will disintegrate at some point in some way, only with the additional qualification that this development will be the consequence of powerful political events, and not some predictable surrender to speculators and the markets.
As Trichet's actions and comments have shown today, the Europeans do not possess a large list of options for dealing with the market. They have a large and varying set of economies with greatly differing growth potentials, and uncommon definitions of optimum performance. What seems like a great boon to Germany, is the bane of Greece or Spain, and vice versa. To manage these, they have the ECB, and the various pacts and agreements that they have signed over the years in order to streamline economic performance and regulations in the region. These tools have been proven to be inadequate to the task by the Greek scandal, and the subsequent disarray of the European sovereign debt market. Now that the major powers of the region hesistate about accepting the inevitable burden that they have to shoulder in order to ensure that the European project survives, traders are turning their eyes to the ECB and the bureaucrats to do something to prevent the Euro's demise, yet fail to find anything of much value.
This is not suprising. After all, Europe is old, its population is old, and the way it conducts itself is old-fashioned, rigid and conservative in comparison to the U.S., or the rising nations of the world. Right now events necessitate bold trade-offs and courageous sacrifices on the part of the Europeans, both of which naturally demand leadership and moral strength in order to be brought to life. If it were that by doing nothing the Europeans could deliver the necessary remedies for the Euro, as they did during the Iraq crisis, the Georgian Crisis, or in the course of the Israel-Palestine conflicts, they would have done so once again, and pretended afterwards that they are only being disciplined and principled by not taking action to react to market events. Unfortunately for them, this time markets demand action, and quiet a lot of it, and no amount of rhetoric, or moral pontification, which were amply provided by the ECB chief today, will satisfy them into trusting the E.U.'s future.
We are a bit surprised at the ostrich-like complacency of European authorities, as they seem to genuinely believe that by doing nothing they can wish the crisis out of existence, or by merely declaring loudly that they are "aware" of the gravity of the situation, they can somehow avert its turning into a region-wide contagion that threatens the survival of the union. On the one hand, official after official expresses his "utmost and unshakable confidence" in the future of the Eurozone and the currency, yet the same officials refute time and again the accusation, as they apparently perceive it, that they are plannning something significant enough to ensure their survival. And it is a little strange that they can at times be victims to the illusion that, after repeatedly assuring everyone that Eurozone's creditors are safe from losses and restructurings, they can make the same creditors agree to a share in the burden just out of a sense of altruism towards politicans, or from a sense of civic responsibility towards nations and economies of which they are not even citizens. In any case, markets are not renowned for charitable generosity, and the PM of Europe's largest nation should at least be aware of this much when she makes her opinion known to the rest of the world.
Today's ECB news conference has led to little more than confusion in the market which seems to be staging a rally right now after being battered over the past weeks. Mr. Trichet did not appear particularly alarmed, probably on the notion that fundamentals in the region are strong enough to withstand bond sales by frightened investors or greedy speculators. Perhaps by looking at the large budget cuts enacted by various government over the past months, and the size of the EFSF, he is assuming that any Euro breakup scenario is outlandish speculation by overexcited traders who are known to be bipolar in their behavior. But even if that were all true, he should be alert to the fact that the past three years have provided sufficient evidence that a conventional analysis of facts may not always represent the hidden and incalculable risks that lead to very surprising market behavior. Caution, and not pink glasses would serve the ECB Governor better now as he seeks to ensure the stability of his domain of responsibility.
