Part 1: Prior Week Market Movers & Their Lessons For the Coming Week
There were 3 stories this past week that actually moved markets.
1. Monday & Tuesday: Rumor Of IMF Aid To Italy
Monday: A Rumor Of IMF Aid To Italy: The Italian paper La Stampa reported a rumor that the IMF was considering providing up to €600 bln of loans to Italy, which the IMF quickly denied. No matter, markets were primed for at least a “dead cat” bounce because:
a) Risk assets were beaten down and so those holding short positions were ready to take profits at the slightest provocation
b) Markets expected some kind of big news soon.
Thus the mere rumor of a big announcement was enough to start the short covering and bargain hunting fueled bounce that one expects after over a week of steady declines in risk assets.
While this rumor got most of the attention and credit for Monday’s rise, the news that actually mattered was…
c) Tuesday: EU Approves Another €8 bln for Greece. True, this was widely expected, hence the rise Monday off of Friday’s lows. Without this latest toss of cash into the Greek bonfire, a Greek default and global banking crisis worse than that of the “Lehman moment” of late 2008 was only days away with no solution in sight. That risk would likely have outweighed the IMF Italy aid rumor.
d) Note: That’s €8 bln out of about €12 bln needed just for Greece’s debt payments due before the end of December 2011. That means we’ve got at least one more chance for another Greek default drama in the coming weeks
2. Wednesday Coordinated Central Bank Move To Ease European Bank Liquidity
Early Wednesday, the Fed, ECB, BoE, BoJ, BoC and SNB announced they’d lower the cost of swapping dollars. The obvious goal was to make it cheaper for cash starved European banks to borrow dollars. These banks get their loans from their own central banks, which in turn borrow from the Fed, which is why the Fed led the move. Given the fear needed to prompt such a drastic act, there was speculation that at least one large EU bank was on the verge of default.
As a look at any daily chart of any risk asset of the past week shows, this was the big event last week. Risk assets saw their biggest single day jump in months. Of course the move was purely technical, as traders assumed everyone else would be buying risk assets. However, the EURUSD barely rallied, and closed the week slightly down from Wednesday’s close, so this remains just a short term bounce until proven otherwise.
As was widely pointed out, the only reason that European banking is having liquidity problems is that it’s insolvent once you consider the likely value of GIIPS bonds. On average European banks are leveraged ~ 26:1 i.e. own 26 times more assets (have outstanding loans) than their actual equity. Given this leverage, it only takes a 4% default rate to wipe out the equity and bankrupt them.
Thus far, Germany remains opposed to any aid plan that could be implemented in time to prevent a crisis:
- Bailout fund expansion
- ECB money printing to fund unlimited bond purchases that would lower sovereign bond rates for the GIIPS and others
Any of the current solutions on the menu mean Germany accepting further liabilities on its balance sheet for the sake of the GIIPS. While Germany may talk about preserving the EU, its actions thus far suggest it’s unwilling to actually do anything that might jeopardize its own credit rating.
So the Fed’s move was likely the only option available. We see no hard evidence that Germany is willing to further jeopardize its own balance sheet and credit rating.
In sum, the central banks applied yet another short term deferral of the coming banking crisis, and markets reacted accordingly.
Whether or not the EU lapses back into crisis will likely depend on events this week. See our weekly preview for details.
3. Can You Print Your Own Money?
There were a number of articles out this past week highlighting how credit markets are valuing the ability to print your own money more highly than any other economic fundamentals.
Currently the UK is able to borrow at a lower cost than Germany, despite Germany’s vastly superior economy. The only explanation:
- The UK can print its own money as needed to repay its obligations
- The UK doesn’t have Germany’s potential direct exposure to GIIPS debt
See here for details.
That was it for market moving events. The S&P 500 and most other risk assets gyrated but were little changed from Wednesday’s close over the final days of the week.
Noteworthy But Not Market Moving
Fitch Lowers Outlook On US Credit Rating From Neutral To Negative: Congress’ inability to identify $1.2 trillion in deficit reduction measures is preventing U.S. fiscal finances from improving. The dollar barely reacted because Fitch kept the U.S. credit rating at AAA, (vs. S&P, which stripped the U.S. of its perfect rating in August).
Anxieties reached new heights in Europe after another bad Italian bond auction had benchmark 10 year rates over 7% and a French newspaper (via Reuters) said S&P could downgrade France’s credit rating within 10 days
The ECB was unable to fully “sterilize” its bond purchases at its weekly tender, meaning that it was now printing money.
PBOC lowered reserve requirements for banks by 50 basis points to improve faltering growth, confirming that it has shifted from tightening to easing mode.
Renewed rumors of an ECB/IMF deal involving ECB lending to the IMF, which would then provide support to other countries in need. The report prompted a brief EURUSD move, which was not sustained due to both lack of confirmation and its being too small to help Italy.
Lessons And Ramifications
Our bearish stance remains unchanged from last week; thus far we view last week’s move as yet another short term rally on sheer hope and a technical bounce.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.