Markets Focus on Today's Eurozone Debt Auctions, CDS Rates Rise, Stocks Fall

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.

China Raises Interest Rates Again; Markets Charge On

So what exactly is driving markets onwards these days? Certainly, China`s third hike of interest rates since the beginning of the current cycle should ring alarm bells for all but the most hallucination-prone members of the bull camp. Isn`t it Chinese purchases driving commodity prices higher? Isn`t it cheap Chinese products that keep the cycle going for those like Japan and the U.S., whose companies and consumers would get a severe shock if the Chinese workers were able to demand the just rises in pay that they deserve? And isn`t the Chinese banking system the third pillar of the global bubble, ensuring that even the craziest "investment" ideas will get funded? These and many other Chinese factors should make any believer in the bull phase extremely cautious and nervous about where the market is headed, including those brave souls who are brave enough to ignore the turmoil in the geostrategically pivotal Arab World, or the explosive E.U. But no, nothing matters for some except for cheap dollars and the same old game of borrowing to speculate, and that the Fed rules all.

The PBOC has raised its benchmark from 5.81% to 6.06% in response to inflation reaching the highest levels of the past 3 years. Chinese inflation has hit 4.6% in December as most readers of the blog would know, but it is a lot lower than the situation in much of the emerging market world. Put simply, there is too much money gushing in to these places and too little enthusiasm from central banks to combat the inflows through capital controls or interest rises. The outcome is rampant inflation, but inflation is probably the least of the ills that the discrepancy between advanced economies and the developing world will bring about. Above all, we have the boiling speculative bubbles that stretch all over the world from Turkey to South Africa to Israel and of course China. Bubbles characteristically end with rate rises (recall the gold and commodity bubble in late 70s that was killed by Paul Volker, or the stock market bubble in 2000 that was popped unwillingly by Alan Greenspan). If inflation causes interest rates to come higher, and causes these bubbles to pop, we may well have the worst economic disaster of the post-WWII era in a collapse that may well dwarf anything we experienced during the banking crisis. Because that one has been made to spread to all segments of the world economy by the experiments of central banks.

Commodities and EM stocks are the only ones for now to experience the reaction of the markets to the Chinese decision. We do not expect even gold to come unscathed if the Chinese keep tightening to perhaps as high as 10%. While that is a distinct possibility, we do not think that the PBOC will risk pushing the brakes too hard, as China will be one of the hardest hit when their engineered bubbles explode.

Markets Focus on Today's Eurozone Debt Auctions, CDS Rates Rise, Stocks Fall

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.