There are 4 likely market drivers for the coming week. Only one is truly dominant, and to profit from it, you need to ask and answer 3 key questions.
First, some background.
In case you ignored market news for the past 2 weeks, here's all that you need to know in order to understand what's coming.
For the 3rd straight week, ever since markets became focused on the risks that the May 6th Greek elections would result in Greece reneging on its bailout deal, there has been only one real market driver.
Global financial markets have been moving almost exclusively on news related to the likelihood of Greek default, and more importantly, the implied contagion risk. Specifically, that a Greek default would result in:
An end to EU aid, causing a collapse of the Greek banking sector both from losses on their Greek bond holdings and cash drain as depositors withdraw cash while they can.
Chaos in the financial and banking sectors of the rest of the GIIPS, most importantly too big to bail or fail Spain and Italy, as both credit markets and depositors treat them bigger versions of Greece awaiting similar fates. Both have already seen their banking sectors' credit ratings downgraded, and benchmark 10 year sovereign note yields top the psychologically important 6% line (already unsustainable, but also one step closer to the 7% level believed to indicate bailout or default unavoidable).
Ghastly uncertainties as the world enters a panic phase theoretically much worse than that experienced by the 2008 Lehman Brothers bank collapse, because:
The EU is not as capable as the US was of moving quickly to do what's needed to calm markets with guarantees of bank stability. The US is one government with only one President, central bank and treasury. Right or wrong, it can reach policy decisions and act on them far faster.
Potential third party exposure to sovereign states, especially big ones like Spain and Italy, is obviously far greater than it was for one US investment bank. The full scope of these is unknown. Theoretically much of that exposure was hedged, though as we learned in 2008, default hedges often fail in market panics because they aren't designed for them. Like your insurance company cannot pay more than a small fraction of its policy holders at any one time, those providing the hedges typically don't anticipate the volume of claims from a rare market wide collapse. The reported loss by JP Morgan due to a failure to hedging failure provided an ill-timed reminder that even the supposedly best managed financial institutions remain vulnerable to human error.
Given the likely widespread exposure of most major banks and financial markets to such large economies as those of the EU (all heavily exposed to Spain and Italy), the first reaction of markets will be to sell. Hard. Really hard.
1. EU Contagion Related News: They Say Greece, They Mean Spain & Italy
Ironically, while events in Greece are likely to move markets on a daily basis, over the longer term what happens in Greece is irrelevant. Why? Because even if Greece elected a government that unanimously promised to uphold its agreements with the EU, would you believe them? Over the past years they haven't, their economy is even worse shape than ever, so why should anyone believe them anyway?
If however, you believe Greece will elect a pro bailout government that will actually fulfill enough of its obligations to keep the funds coming, stop here, the rest doesn't apply. For less optimistic, here's what to focus on for the coming weeks.
2. Only Three Questions Matter Regarding The Eu Contagion Threat
The only real question for virtually all financial markets and asset classes in the coming weeks is:
Key Question #1
Will the ECB, and probably the rest of the major central banks (led by the Fed), will once again surrender the current game of chicken and step in with yet another massive dose of cash to stave off the above contagion threat? Or, do they decide to stop throwing good money at a lost cause?
To answer that question, let's first lay out a few points.
If they elect to provide more aid, its terms are likely irrelevant: The conditions attached are probably also as irrelevant as the Greek election results, for the same reason. Greece can't pay, so it won't. The money is for preventing a collapse in Spain and Italy, and saving the EU and global economy. Greece? Child, please. Greece can't repay, and the EU isn't ready to send in troops to enforce repayment.
Yes, the game cannot go on forever, because the moral hazard created would eventually mean on decades of cash giveaways to the rest of the GIIPS, for the same reasons, printing mountains of cash, debased currencies, etc.
Key Question #2
Therefore, to answer #1, we need to ask a second, more fundamental question:
Have EU and global leaders completed preparations to prevent the feared contagion, market and economic crises likely to follow from any GIIPS nation default?
–If so, then Greece will be left to face its eventual default in the coming weeks, because the only reason for providing the handouts of the past no longer applies.
–If not, then the same contagion risks apply, and we can expect the game to continue: more bailouts, money printing, tough conditions attached, (wink, wink), wash, rinse, repeat.
Because we don't really know, the better question may be, what are the odds of that they EU, Fed, et.al are ready for a Greek default without contagion?
Our answer: thus far, not good.
We have seen little evidence of progress towards the capacity for quick and decisive action needed to keep a Greek default's effects largely limited to Greece. Specifically, is there a single body that can guarantee the liquidity and ultimate solvency Spanish and Italian banks, and as well as Spanish and Italian sovereign debt on which these banks have bet their existence?
The huge caveat to this conclusion is that IF they've made such provisions they're likely to come as a surprise, announced as part of the remedy to the shocker announcement that there will be no more aid and so Greece is effectively insolvent, out of Euros, and must return to the Drachma or reasonable facsimile.
The surprise element is needed to panic driven market collapses, prevent bank runs and other symptoms of market panic. Market and bank holidays may also be on the menu, along with capital controls, short selling bans and more.
This leads to the third question.
Even if the Troika and related parties like major central banks have got a plan ready to implement, can they keep it a secret? Will we have any advanced warning?
Our answer: probably, if you know where to look. While the most sophisticated players may be able to hide their advanced knowledge in "dark pools" of capital outside of publicly monitored and regulated markets, the big money movements should appear soon enough in public risk asset markets.
See the first part of LESSONS & RAMIFICATIONS below for specific markets to watch.
3-4: Other Likely Market Movers
The other likely sources of market moving events include:
3. Technical Support Levels Combined With Official Spin Control
Given both the recent fear level and likely coming attempts to calm markets that typically occur during the annual spring Greek default panics, technical support levels on daily and weekly charts could provide some stability, particularly when leaders attempt to talk up markets. Oversold markets are more likely to bounce on even the most minor justifications as traders seek opportunities to book short term profits.
The weekend's G8 meetings, speeches by key central bank figures, and other official meetings might provide occasions to stem the pullback in risk assets. Remember, despite the scary headlines, many risk barometers, particularly those not closely related to the last EU troubles (like US stock indexes) have not dropped dramatically relative to their recent highs, but rather from a technical perspective are just in a normal pullback phase.
4. Economic Calendar Events
The coming week's calendar is a typically relatively quiet 3rd week of the month. Highlights include:
UK: CPI, public sector net borrowing, BoE inflation letter
US: Existing home sales
Japan: Rate statement and press conference
UK: MPC meeting minutes, retail sales, revised GDP
Canada: Retail sales
US: New home sales
China: HSBC flash mfg PMI
EU: French, German, EU mfg and services PMIs
US: Durable goods, first time jobless claims
LESSONS & RAMIFICATIONS
For Short Term Traders (Time Horizon Coming 1-6 Weeks)
In general, keep an eye on the markets with big players with the best intelligence:
Credit Markets: CDS spreads for GIIPS sovereign and bank debt
Forex Markets: The EURUSD and other currency pairs with EUR components.
Commodity Markets: Particularly gold, not a risk or safety asset (see my recent posts here and here). Whether or not the next big EU rescue plan includes printing mountains of unsterilized cash, markets are likely to assume that it does. New stimulus programs have generally been very good for gold and other fiat currency hedges due to the implied risk of lost purchasing power. Note that gold made a dramatic bounce last week. It could easily have been just a normal technical oversold bounce. However, it could also betray at least a suspicion that, as in the past, Team Troika is ready to step in with cash to buy more time to find a solution that prevents another global meltdown.
Other risk asset barometers: major stock indices should be close behind in jumping higher.
For Longer Term Traders And Investors (Multi-Month Holding Periods)
Past behavior of the Troika and other major central banks, as well as the US government in election years, suggests they'll seize any chance to defer a crisis, even if that deferral raises the risks of a more cataclysmic default wave later.
The likely result is more money printing from the ECB and Fed, with the BoE and others doing their part too. While inflation could be limited in low growth economies that avoid stagflation, ultimately that should mean loss of purchasing power, particularly as economies stabilize and recover, and pent-up deferred spending starts chasing a limited number of goods and services.
In the most general terms, that means avoiding at all cost being stuck with your wealth in just one currency, particularly the USD and EUR, which are likely to see the most currency dilutive policies in the near term. As noted in recent posts, I'm no fan of the JPY or GBP as long term stores of value.
For Further Guidance
As I've recently explained AVOID MOST COMMON FATAL INVESTOR MISTAKE (Part 1), just because you earn and spend in one currency, you're not insulated from the effects of its declining purchasing power.
Fortunately there are a variety of relatively simple ways to do this without opening brokerage accounts all over the world or getting involved with excessively risk or demanding kinds of forex trading. Finding conservative, sensible advice suitable for most risk averse traders and investors in one convenient place or book hasn't been easy. So I've spent the past years pulling together the best solutions in the coming book, THE SENSIBLE GUIDE TO FOREX, SAFER, SMARTER WAYS to SURVIVE and PROSPER from the START (includes links to where you can lock in the lowest pre-release price and reserve a copy for when it's released) See this link for why and how this book is your best guide. For a sneak preview of advanced reviews, see here.
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The best defense we savers and investors have is to show them we can vote with our wallets and invest via currencies managed by more responsible governments. Yes, politicians much prefer to inflate away debt rather than raise taxes or cut entitlements. However we don't have to fund their political careers by accepting stealth taxation of currency dilution.
Disclosure/disclaimer:No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.