A Lean And Hungary Look
The prior week:
- Quick review
- Implications for the coming week and beyond
Coming week’s likely market movers
1. EU Debt Crisis-risks to watch:
- Further news on Hungary, other new sovereign debt skeletons popping out of the closet
- Government stability
- Progress in deficit cutting, especially
i. political and labor opposition
ii. GDP and employment slowdowns from deficit cutting
4. Bank stability
2. Wildcards: Watch for updates on:
- China construction and housing data
- US: banking scandals, housing market and affects on bank finances, BP oil spill
3. Economic Events: US Retail Sales, RBNZ interest rate decision and comments, ECB, BoE rate statements.
The Prior Week:
What a difference a day makes. As the chart below (click to enlarge) shows, until Friday the week looked so different.
S&P 500 Daily Chart May 4th – June 4th
If the week had ended Thursday, the bellwether S&P 500 would have ended the week essentially unchanged at just above 1100 and up over the prior 2 weeks, the first time that would have happened since April 12th – 26th, when it sat above 1215 for the first time since September 2008. Overall US stocks were up over 1% on the week.
Currency traders were trimming USD shorts as the USD rally appeared to be nearing a likely near term pause and reversal as the EURUSD approached what was believed to be strong support at $1.20. The pair was just above its historic range at 1.2130, closing Thursday around 1.2160.
Then a few hours before the US markets opened Friday, the new government of Hungary announced that economic conditions were grave and that talk of default was not an exaggeration. What’s more, the country did not plan to put austerity measures in place, leading many wonder whether the already overextended European Union (EU) would have to provide a bailout. Rumors that a major French bank was in trouble, as yet unfounded, may have exacerbated the fear.
That Hungary is not part of the euro-zone was irrelevant, neither was Dubai. Nonetheless the Dubai crisis last November transformed the whole EU default threat from a mere potential threat in the future into a malignant one as Dubai focused everyone on the sovereign debt threat.
The news once again fanned uncertainty about which countries and banks could see their financial stability undermined.
The past 2 years, especially the past 2 months, have taught markets well about the new reality, which is:
No one really knows who is endangered by which defaults, hence ANY default threat casts doubt on everyone’s solvency. That means:
- Interbank lending stops
- CDS spreads explode higher
- Otherwise viable governments and banks get pushed closer to actual default from lack of affordable/available short term credit
In sum, as long as there is no clarity on risk, there is no trust in the banking system and no calm in the markets.
By 9:00am GMT, Friday, the EURUSD and risk assets in general were in freefall. Whether a blowout US monthly jobs report with stellar private sector hiring figures might have stemmed the tide is irrelevant, for the reports were overall disappointing, and simply threw fuel on a market that was already burning down. The key points:
- US employment is not meaningfully improving. While private sector employment improved, it contributed only about 10% of the total job growth, about 41K new jobs vs. 180k forecasted. Stagnant private sector hiring meant that the otherwise not so bad employment gains (413k vs.520k expected) were from temporary US government census hiring that would likely reverse back down in the coming months.
- The seemingly positive declining unemployment rate reported (from 9.9% to 9.7%) was based on a shrinking pool of job seekers as discouraged workers gave up seeking work.
Implications for the Coming Week and Beyond
EU uncertainty remains the key market driver
Events feeding continued uncertainty about the next likely dominos to fall remain the biggest threat to markets, and for good reason. See here for details from Zerohedge. See below for specific events to watch for that could send markets shooting up or down.
Overall Markets’ Trend: risk assets down, safe-havens up
- With no resolution of the EU’s woes (or Japans, the UK’s or America’s, but it’s the EU that has the most trouble and is thus the focus for now) the longer term trend remains down for risk assets, the medium/short term trend flat to down, depending on how the below market drivers play out. No bottom expected until stocks are 24% below their 200 day moving average and 12% below their 50 day moving average. See Three Powerful Bearish Signs: S+P 500 Heading To Around 830, Short Risk Assets for details.
- For lack of an alternative, the classic safe-haven assets like JPY and USD will continue to show relative strength, as will their AAA bonds, regardless of how bad their own fundamentals are. That buys them some extra time for their banks and housing markets as low bond rates minimize the damage from rising mortgage rates and default rates, though the US housing picture remains extremely bleak even under these conditions. For reference, look to the extremes seen before the March 2009 rally as likely support levels.
- The same goes for gold, which is ultimately just a more established fiat currency (has value as long as markets say so, but of little use). As noted repeatedly, it is neither a risk nor safe-haven asset, but rather a currency hedge. As long as the EUR or USD are trending down, gold should do well. We see gold re-testing its 1240 highs in the coming months as long as the EUR fails to find a bottom, and going well beyond if ANY major bank or country approaches default.
Forex: EUR/USD: To parity and beyond.
- The ECB likes a weak Euro: Chinese sensibilities aside, the ECB has no motivation to prevent a EUR collapse
- The SNB abandons support: As in the past, the SNB did not fight a market stampede. However, it is likely to intervene in times of low liquidity to keep Euro shorts from getting extreme and thus to slow the damage to Swiss exports to the EU from a rising CHF. As long as the EU remains so troubled, forget about any significant SNB support for the Euro. That battle has been lost.
- Both EU and US officials will maintain dovish policies. With no near term inflation threat and very fragile economic recoveries, both can be expected to keep rates low, regardless of what the OECD, IMF, or anyone else recommends. The Chinese can’t do much about it, but they’ll try to minimize the damage a bit.
Disclosure: No Positions