Part 1: Prior Week Market Movers & Their Lessons For the Coming Week
Rumors About The Grand EU Crisis Solution
Watching the EU now is like watching one of those movie scenes in which the hero has mere seconds to defuse a ticking nuclear bomb. Now imagine the hero has2 heads, and each head disagrees on which wire to cut, and whether to cut wires or just smash the clock with a hammer. As of Sunday October 23rd, latest reports suggest significant disagreements remain, as the realization dawns that there are no good solutions (surprise!)
Markets moved with rumors on the coming solution for the EU debt crisis, which is expected no later than at the end of the October 26th summit Wednesday. That’s it. Everything else was and will be mostly irrelevant, because the EU remains THE existential threat to markets and the global economy. With weekly credit downgrades and rising CDS spreads, the EU is literally in a race against the clock, seeking to calm markets and buttress its banks before being swept under a wave of defaults that could suck down the rest of the world with it.
Here are the key points from the prior week.
- Monday: German Finance Minister Wolfgang Schaeuble said there wouldn’t be a comprehensive solution to the EZ debt crisis coming out of the October 23 weekend ECOFIN summit. This doused hopes raised by Merkel and Sarkozy on October 9th, when they promised a comprehensive solution crisis by the end of the month.
- Tuesday: Markets closed the trading day in New York higher on a report hinting that France and Germany were concluding an agreement on a €2T rescue fund, though they fell back from highs on doubts about this.
- Wednesday: Risk assets closed the day lower on a Reuters report that French President Sarkozy said the EZ debt talks had stalled on disagreements. The Fed’s gloomy assessment of the US economy didn’t help.
- Thursday: While Asia and Europe were lower, a late report after they’d closed but while the US was still open said that a bailout plan would be approved in a newly scheduled meeting Wednesday October 26th. If nothing else, this did confirm reports that the weekend October 23rd meeting would not yield the anticipated solution.
- Friday: Markets again rallied, fueled mostly by news from a German official that German official came out and said the concerns over disagreements were exaggerated, and confirmation from EU Council President that a second summit would occur on October 26th, which is when the big solution is expected. Thus Wednesday remains the focus for the coming week. If markets like what they hear, the nascent risk rally is on, with special benefits to the EURUSD. If not, expect the opposite.
See Part 2 for details about the rescue package and what it must accomplish to succeed.
Other Noteworthy Issues
While nothing else besides rumors about the EU rescue plan really moved markets, there were other noteworthy events last week.
Credit Downgrades: The Whip At The EU’s Back
We are seeing weekly credit downgrades of GIIPS sovereign and bank debt. We are also seeing rising CDS spreads, meaning rising costs to insure these bonds against default, which means markets see the EU as increasingly risky and thus borrowing costs for EU nations and banks are rising beyond their reach. When that happens, default and economic collapse will quickly follow. So the EU is literally in a race against the clock, seeking to calm markets and buttress its banks before being swept under a wave of defaults that could suck down the rest of the world with it.
Downgrades Of The Week
Here’s a brief recap:
The pressure for a solution is intensifying from the accelerating trend of credit downgrades.
Wednesday: Moody’s cut Spain’s government bond ratings by two notches to A1 from Aa2 with a negative outlook, due to a lack of resolution to the Eurozone crisis, a slowdown in the economy and the resulting difficulty for Spain to meet its fiscal targets. This came just after the agency had also put Italy and Belgium on review.
Moody’s also downgraded 9 Spanish regions and 2 Basque provinces as recent audits uncover more debt.
S&P downgraded 24 of 43 Italian banks it covered.
Top German economists are reported saying that France’s AAA rating could be in danger if additional steps needed to prop up indebted EZ members or save ailing banks
Friday: S&P warned it would probably cut France’s AAA rating, and also cut ratings of Spain, Italy, Ireland and Portugal, if the EU falls into a double-dip recession.
Troika Approved 6th Tranche of Cash For Greece
No surprise despite Greece’s failing to meet targets and being unlikely to do so any time soon. As we’ve said before, the EU will do what it can to prevent defaults until it believes the banking system is ready to survive them.
Overall earnings were ok to good, but they were drowned out by events in the EU.
Rising Prospects For QE 3
Comments by Fed Governor and FOMC voting member Dan Tarullo renewed speculation that the Federal Reserve will pursue a third round of stimulus in the coming months, after he explicitly stated support for additional, large-scale mortgage backed security (MBS) purchases to help lower mortgage rates and thereby boost the economy. We have heard other officials say they are keeping their list of options open; but this was an explicit call for QE 3.
Lessons & Ramifications For Next Week: Watch Those Divergences
Obviously, markets are likely to stay locked in on the EU. See Part 2 on coming week market movers for more on this.
Longer Term Implications
In the short term we could easily see a relief rally, though if so, odds suggest it will be temporary. We remain skeptical about the prospects for a long term EU fix any time soon.
There are too many cooks, too many complications, too much money to fix relative to the political will of the voters (who may object to attempts to strip them of any say – more on that in Part 2). We don’t believe the EU is ready for needed centralizing of budgets and loss of individual national sovereignty. To avoid getting too swept up in any near term optimism, consider keeping the decision tree (from stratfor.com via seekingalpha.com) about Greece pinned up near your computer. It’s one of the best summaries of the EU crisis extant. Its message: a banking crisis is inevitable.
(stratfor.com via seekingalpha.com) 02oct 22 2359
When correlations between markets break down, that’s something to watch. Here are two worth noting.
S&P 500 Diverges From Other Markets
While the S&P 500, our preferred barometer of risk appetite, made a nascent break higher Friday, the move was not confirmed by similar risk appetite indications in other markets: major indexes, forex , commodities, or 10 year bonds.
- Forex: Except for the GBPUSD, major forex pairs did not move confirm rising risk appetite. Most other higher risk currencies were flat or lower vs. the USD, and the more safe haven CHF and JPY both advanced against the USD. The EURUSD was slightly higher on the week, but its weekly chart shows a potentially bearish hanging man pattern (needs confirmation from next week’s action).
- Commodities: These too were almost all lower.
- Other Indexes: The DAX (Germany), CAC (France), FTSE 100 (UK) and Nikkei (Japan) and Hang Seng and Shanghai (China) all closed the week flat or lower.
- US and Japanese 10 year notes were higher on the week.
Why the divergence? A few ideas:
- The S&P 500 may be responding to a growing chance of QE 3 as noted above. US earnings have been supportive too, though these tend to be reflected similarly in all markets.
- Forex, bond, and commodity markets tend to pick up changes before equity markets. That other major equity indexes are also lower on the week may simply indicate that the S&P 500’s divergence from other markets is simply a random temporary event-the index is a good indicator of overall risk appetite, but not 100% guaranteed.
Euro Diverges French Sovereign Debt
“Remember your correlations – the euro is cruising along even as French government debt goes into the tank. A reversion to the mean points to either a sharp rally in French paper, or a big dive in the euro coming soon.” From zerohedge.com (via seekingalpha.com)
(via zerohedge: here) 01 oct 22 2338
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.