Global equity bears are taking no prisoners today. Most of the US markets are down about 4% at this writing, better than most of the European indexes. The Euro Stoxx 50 is down 5.34%, French CAC 40, down 5.48%, the German DAX down 5.82%, the Italian FTSE MIB down 6.15%, and the winner in the race to the cellar is, the OMX Stockholm 30 Index, down 6.73%. This is a work in progress.
In turbulent times, the key to making money is not losing what you have. As we have mentioned in "Is the Pound Really a Haven Currency?" money by the billions has been flowing into the US Banking sector. Despite the S & P downgrade, the money flow into US Treasuries has pushed the price up and the rates down. It appears this is hot money, fleeing Europe, fearful the ever evolving debt crises will result in a credit freeze, possibly capital controls, and panic.
Markets were already cascading to the down side when a Wall Street Journal article said:
"U.S. Federal Reserve and state regulators are intensifying their oversight of the U.S. subsidiaries of Europe's biggest banks to measure how vulnerable the divisions are to increased financial pressures, people familiar with the matter told The Wall Street Journal. The concern is that the euro-zone debt crisis could impair the banks' ability to fund loans and meet other obligations in the U.S., the Journal reported."
The interlocking nature of the the US and the European Banks is a problem on both sides of the Atlantic. US savers, looking for safety, have invested in money market funds. The Fed, under Bernanke, with his cheap money policies, has exacerbated the flow of money market funds off shore in search of higher yields. An article by Desmond Lachman in The American identifies some of the pending problems:
" A European failure to contain its debt crisis would be a monumental electoral setback for Obama...... it is because a European failure is bound to have huge ramifications for U.S. and global financial markets.
If there is any doubt on this score, all one need do is consider the massive exposure that the U.S. financial system has to European banks. In a recent survey, the Fitch rating agency found that, as of the end of May 2011, the U.S. money market industry had direct exposure of around $1.2 trillion, or around half of its overall assets, to the European banking system. And the Bank for International Settlement reports that U.S. banks have direct exposure to the periphery through derivative contracts of close to $500 billion, as well as loan exposure to German and French banks in excess of $1.2 trillion.
The over-exposure of the U.S. money market funds and banks to the European banking system should be keeping Obama awake at night. Those European banks in turn are all too exposed to the $2 trillion sovereign debt market for Greece, Ireland, Portugal, and Spain. Underscoring this point, the IMF has recently estimated that the European banks’ exposure to the European periphery accounts for around 80 percent of those banks’ capital bases. And those banks have yet to recognize the large loan losses that they are bound to experience on those debt holdings."
During the Lehman crises, it was the US Federal Reserve that injected massive liquidity into the global banks. Without the Fed's actions, the credit freeze and panic would have lasted longer, perhaps a lot longer. There have been objections to the Fed's "bailing out the world's bankers" the last time. Another crises will not be pretty, likely a political hot potato.
Though money is flowing into the US, news from the economic front is not good. It was reported that manufacturing firms in the Philadelphia Fed region dropped to a negative 30.7, a sharp decline from the expected positive 4.0. US existing home sales were short of expectations and the month/month CPI at 0.5% higher was worse than expected.
Yes the US news is bleak, but an emerging solution to the euro debt problem is not evident. Germany may lack the political will and the financial ability to cover the debt load of Europe. We are inclined to sell the EURUSD on a rally back to the 1.4390 area. An alternative trade to consider, buy the USDSEK as the pair sells off to 6.39.
Watch your stops and remember Bernanke is going to give his Aspen speech late next week.