The past week’s continued rally was mostly on rising hopes for progress on the EU crisis. No one believes the big ultimate solution is coming soon. That would require two huge commitments we don’t think the EU is ready to do:
- Place national budgets under centralized EU control in order to avoid a repeat crisis. That means ceding a huge chunk of national sovereignty. How much control does a nation have if foreigners can determine its budget?
- More bailouts from funding nations, probably more austerity or asset sales from debtor nations.
A. Technical Picture: Bullish Double Bottom Awaits Confirmation
If there’s no breakthrough news justifying higher markets, technical resistance could be enough to spark profit taking and prevent further rallies in risk assets.
As the chart below shows (click to enlarge), we may be completing a bullish double bottom pattern that suggests the end of the down move that began in late July (A). For confirmation we’d need a sustained break above the 1120-60 zone, which includes:
- The neckline around 1220
- The 100 day EMA also ~ 1120 (not shown)
- The 200 day EMA around 1230
- The 61.8% Fibonacci retracement of the July downtrend (A).
- Some room for the usual random market noise and false breaks higher
As always, take these patterns as a useful guide, not inviolate truths. Because so many traders pay attention to these patterns, they create a degree of self-fulfilling prophecy which you shouldn’t ignore.
That’s the very simple technical picture facing us at the start of the week. Now let’s look at the likely key fundamental drivers for next week’s markets.
B. Fundamental Picture: 10 Things To Watch
Reasons 1-8: EU Crisis Related Events
1. Market Reaction To Last Week’s G-20 Meeting
A. New Bailout For Greece: Greece remains the central problem, and needs another bailout in addition to the €110 billion ($152 billion) program granted in May 2010. France and Germany still don’t agree on the details. While risks of further haircuts for Greek bondholders have receded, they aren’t gone, as there are German officials who still want them.
C. An Enlarged Bailout Fund To Reassure Markets: Euro-zone nations are trying to boost their €440 billion ($606 billion) bailout fund, the European Financial Stability Facility (EFSF), possibly via an insurance program to guarantee investors some protection against losses in European debt. Expanding the effective lending power of the EFSF is arguably the key to restoring enough confidence to halt the contagion hitting bonds of Spain and Italy. The difficulty in achieving the recent relatively modest EFSF expansion suggests the EU is not ready to commit to the €2 trillion believed needed to restore confidence, bring down GIIPS bond yields, and restore confidence (and thus interbank lending) in EU banks.
This past week markets were optimistic, leaving potential for disappointment, made all the more possible by the fact that risk assets are hitting near term technical resistance. If the past is any guide, we expect more disappointment before any final agreement.
There are conflicting reports about whether there will be additional haircuts for private sector bondholders (mostly the EU banks). The last time haircuts were imposed on bondholders (the July 21 Greek rescue package) the result was a worsening of the crisis. The new risks imposed on Greek bond holders drove away buyers of European sovereign and bank bonds that carried any hint of exposure to the GIIPS, including those of Italy and France, which until then had not been touched by the spreading contagion. EU banks, suddenly facing new unknown losses, now looked riskier, and so were cut off from their normal long term borrowing sources. They saw their shares and bond prices plunge, and got hit with a wave of downgrades with more threatened, most recently by Fitch this past week.
Per a Reuters report out this past Wednesday, EU officials are now admitting to haircuts as high as 50%. Many believe the ultimate losses on Greek and other GIIPS bonds will be even higher, some believe much higher. If in fact Saturday’s G20 meeting took further haircuts off the table, that should be a step in the right direction. However it’s unclear whether officials from Germany and other funding nations (beyond France, which opposes further haircuts given the damage they’d do to French banks) are ready to accept this policy.
Other EU Crisis Events
The European Central Bank’s Governing Council will meet in Brussels. While they’re not likely to see any decisions, we could hear rumors about a rate cut in November or even further measures to stabilize the troubled currency area.
Friday, October 21: €2 billion in Greek Treasury bills mature. We’ll probably know by then whether the EFSF has been ratified, and how long the country can hold out.
The EU Council (Heads of State) meeting in Brussels on 23 October may include discussion of a roadmap towards fiscal and political integration. Headlines are likely to be positive, as this is chance to drum up more positive PR. However investors should consider that there are considerable obstacles to overcome that might require more time than markets are willing to grant before some new fear catalyst sparks another EU crisis- driven-selloff. These include:
- Germany and other nations may need a public vote in order to relinquish additional sovereign rights to Europe.
- Fiscal integration will be time-consuming
- Financial resources provided by the EFSF are likely to be inadequate to keep peripheral bond markets supported.
- Bringing the European Stabilization Mechanism (ESM) forward and giving it a bank license suggests an indirect monetization of debt. That would weaken the EUR and thus also raise yields on EUR denominated debt.
The EC/ECB/IMF (aka: The Troika) may issue a final report on Greece. Last Tuesday inspectors “rubber stamped” approval of the next $11 billion in aid for Greece even though Greece failed to meet goals required to get the cash. Still, the alternative was imminent Greek default and, once again, risk of a “Lehman” moment type market crisis. This report is the Troika’s last chance to block the funds. Unless there’s a plan to support banks threatened with default as their Greek and other GIIPS bonds become nearly worthless, we expect Greece will get the money regardless of what the report says.
Mario Draghi replaces Jean Claude Trichet as ECB President. He might use the occasion to announce new steps to combat the EU crisis.
- ECB policy meeting, the first under Draghi, markets expect a rate cut. Expect the EUR to struggle in the days prior to this meeting if these expectations hold, as markets price in a lower rate and less attractive EUR.
- G-20 Leaders Meet In Cannes: If a detailed rescue plan hasn’t been announced already, this is the expected occasion for it. Given their past proclivities for too little too late (unless they can show they got the IMF to pony up too), they may well disappoint expectations. Will markets have patience left for a further wait? That likely depends on whether the G-20 is successful in at least deferring the day of reckoning long enough for a tradable rally yet again.
Last Thursday Fitch warned of coming bank downgrades for some of the world’s largest banks, including:
- Barclays Bank plc (BCS)
- BNP Paribas (OTCQX:BNPQY)
- Credit Suisse AG (CS)
- Deutsche Bank AG (DB)
- The Goldman Sachs Group, Inc. (GS)
- Morgan Stanley (MS)
- Societe Generale (GM:SCGLF)
If somehow the EU is quiet, earnings and the economic calendar may shift focus onto the US. Earnings are the big event this week. This will be the second week of US earnings, and typically these have the most market influence within the first 2-3 weeks. After that, the tone is usually already set and the influence of earnings announcements fades.
These were not market moving in the past week. Markets rose with sentiment on the EU even as earnings disappointed. Google’s good results may have helped the market Friday, but again we believe that was a secondary factor after EU optimism. Bellwether names include:
10. Top Economic Calendar Events
- AUD: monetary policy minutes
- CNY: assorted data which together provide latest look at China: GDP, fixed asset investment, industrial production, NBS press conference
- GBP: CPI
- EUR: German ZEW survey
- USD: PPI, TIC Long term purchases, Fed Chairman Bernanke speaks
- GBP: MPC Meeting Minutes
- USD: Building permits, CPI, Beige book, housing starts
- GBP: Retail sales
- USD: existing home sales, Philly Fed Mfg index
Friday Oct 21
- EUR: Trichet speaks, German Ifo business climate
- CAD: CPI
DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE REALLY KNEW WHAT WOULD HAPPEN, WE WOULDN’T BE TELLING YOU FOR FREE, NOW WOULD WE?