Preview from Europe: FOMC Disappoints the Markets

|
 |  Includes: ADXTF, AOZOF, BA, ORCL, SHI, SKLKF
by: The Mole

Not much to report from the trenches where traders were a tad bemused by the more confident but still diligent Fed FoMC statement. While there was comfort from the assurances that deflation was no longer seen as a major threat and they intend to keep rates close to zero for an extended period of time, there was some surprise at no hint at an exit strategy or any thought of buying more bonds to keep a lid on mortgage rates (which had been on a sharp upward drift of late).

Today’s Market Moving Stories

  • Japanese Finance Minister Kaoru Yosano reiterated his support for Washington’s strong-dollar policy, saying it benefits not only the United States but countries around the world. The dollar has been buffeted by debate about its status as the world’s reserve currency as countries which use Treasuries to park dollars in their foreign exchange reserves, such as China, have fretted about the ballooning supply of US government debt. Yosano repeated there was no change in Tokyo’s policy of regarding the dollar as the world’s key currency and the dominant currency for trade settlement.
  • China should buy more gold because the dollar is poised for a fall and the metal is needed to support the greater international role envisaged for the yuan, Li Lianzhong said, a researcher with the ruling Communist Party. China should use more of its $1.95 trillion in foreign exchange reserves to buy energy and natural resources. Li also said that buying land in the United States was a better option for China than buying U.S. Treasury securities.
  • It appears that the Chinese central government are getting a tad concerned about the asset price bubbles in the domestic economy with news that the banking regulator had sent out investigative teams last week to check whether bank loans are being illegally used to invest in stocks and the property market. The investigation follows an “urgent” statement sent down to banks early this month, ordering them to ensure that there are no sudden surges in credit and that all loans are channelled to help boost the economy. Together, the moves underline Beijing’s concern about the potential of easy credit fuelling asset price bubbles.
  • A leading indicator of US non-residential construction spending held steady for a second month in May, suggesting an economic recovery has stalled, the Architecture Billings Index said. “Numerous firms (have) bid for the same project, which is why the high level of inquiries is not necessarily translating into additional billings for project work at many firms,” AIA Chief Economist Kermit Baker said.
  • US credit card charge offs broke new records according to US rating agency Moody’s.
  • And very-easy-on-the-eye Maria Sharapova wasn’t the only one knocked out by a lady from the Argentine yesterday. US Governor Mark Sanford admitted that he’d secretly flown to Argentina to visit a woman with whom he’d been having an affair. Good to hear the ever fair, balanced and accurate Fox “Redneck” News refer to him as a Democrat last night. Ho hum--shades of Mark Foley.

Money Money Money
The big news this morning everywhere was the ECB’s €442bn 12-month repo auction, the largest and longest-dating ever, through which 1100 European banks have obtained new liquidity. FT Deutschland cites finance minister Peer Steinbruck, once again displaying his full misjudgement of the financial crisis, as saying that the banks would no longer have an excuse to refuse credit. The article points out that the banks have a very good reason to withhold credit, as the rating of its customers has deteriorated due to the deep recession. The article also quotes Bundesbank President Axel Weber as saying there is no generalised credit crunch, but there are credit constraints especially for small companies. The article also cites a survey according to which the credit crunch has become the main reason for insolvencies of SMEs. Insolvency administrators complain that banks with whom the companies had long-standing relationships now refuse credit. So much for “not a generalised credit crunch”. Weber was also quoted as saying that the German government’s forecast of a 0.5% growth next year was too optimistic. He expects zero growth.

House Of Credit Cards

OECD Expects Recovery, But Not Over Here
In its latest forecast, the OECD expects recovery for 2010 everywhere except in Europe. Eurozone forecasts were revised downwards for 2009 to -4.8% from -4.1% while the US was revised upwards to -2.8% from -4%. General Secretary Angel Gurria said the Eurozone and the US are different with respect to the magnitude of the stimulus package, the flexibility of their economy and the transparency about the capital needs of their banking sector. For the Eurozone he recommends further interest cuts, and to continue the unconventional monetary policy as well as the stimulus policies. Countries with margins of manoeuvre should even increase their efforts. He warned Germany not to end stimulus measures prematurely.

IMF Says Nationalise The Irish Banks
Irish banks are again in the firing line following the publication of an IMF report predicting cumulative losses of as much as €35bn by end of 2010. They did highlight that the banking solution proposed by the Government in NAMA “is potentially the right mechanism to separate the good from the bad assets”, and receives endorsement in the report. However, the IMF suggests that it might be easier to price the toxic assets by temporarily nationalising the banks to allow the transfer price of the assets into NAMA to be “less of an issue”. The report comments that nationalisation should be seen as “complementary” to NAMA rather than an alternative. The other key points of the gloomy report are its questioning of the future of universal social welfare benefits, yet more focus on the public service wages bill, a big stress on Ireland’s relative loss of competitiveness and the need for expenditure cuts rather than further punitive tax hikes.

Emerging Markets And Russian Equities To Continue To Struggle
The Russian RTS Index has fallen by 20% over the past month, meaning it is officially in bear market territory. But while Russian markets have been hit particularly hard in recent weeks, it is not the only market in Emerging Europe to have suffered. Equity markets elsewhere in the region are down by around 3% since the start of the month. Going forward, there are several reasons to expect further falls in equity markets across the region.

At a global level, I expect investor risk appetite to wane as the pace of recovery in the world economy disappoints. This is likely to hit equity markets across the world. But those in the developing world and, given its relatively poor fundamentals, Emerging Europe in particular, are likely to suffer disproportionately. In Russia’s case, this is likely to be exacerbated by a renewed fall in the oil price, which I think might drop to $50 next year. In addition, a series of local factors continue to cast a shadow over the prospects for financial markets in Emerging Europe. Most notably, there are growing fears of a devaluation in Latvia. While the base consensus remains for the peg to stay, there is an obvious risk that, if Latvia devalues, the rest of the region could be hit by a wave of contagion, similar to Asia in 1997-98. Indeed, although a super-sized IMF bailout should prevent full-scale financial meltdown in the region, it is difficult to believe that any country could escape the initial maelstrom that would follow.

The other key risk to markets in the region stems from its fragile banking sector. The widespread practice of borrowing in foreign currencies means that the sell-off in local currency markets since the collapse of Lehman’s last September has caused the local value of debt to soar. Non-performing loans could top 20% in a number of countries later this year, meaning further injections of capital are likely to be needed. Again, a beefed up IMF is likely to come to the rescue. But for now at least, it is one more reason to be bearish. While market forecasts are subject to an exceptional degree of uncertainty in the current environment, I’d have penciled in a further 10%

Equities

  • Boeing (NYSE:BA) was a big drag yesterday after reporting another delay for its 787 Dreamliner (which is turning into a bit of a ‘mare).
  • Tech stocks continued to benefit from the tailwind of upside surprise that were Oracle’s (NASDAQ:ORCL) results.
  • In the land of the rising sun, shares of Aozora Bank and Shinsei Bank (OTC:SKLKF) both jumped on news they were in merger talks to create the country’s sixth biggest bank. Both have been dogged by subprime exposures. Japan’s Nikkei average overall climbed 1.6%. Asia’s technology shares were lifted by gains in the NASDAQ the previous day after software maker Oracle posted better-than-expected quarterly results.
  • Sinopec Group (NYSE:SHI) launched China’s biggest-ever foreign oil acquisition yesterday, agreeing to buy Addax Petroleum (OTC:ADXTF) for about $7.24 billion to secure the Swiss oil explorer’s high-potential oil blocks in West Africa and Iraq.
  • According to media speculation, Denis O’Brien may have told Independent News & Media’s board that he does not support a rescue plan formulated by Anthony O’Reilly. The deeply discounted rights issue will not succeed without the support of O’Brien. He may be unhappy that the plan involves giving bondholders 10% of the group’s shares.
  • RBS are bottom of the class. They are the world’s worst bank according to a survey of 1,000 financial institutions.

And Finally… A Penny For Your Thoughts

Disclosures: None