Ignore the mainstream media; there is no credible Spain rescue plan. There are 2 other things to keep you on edge, and 3 other potential market movers just in case markets don't wake up.
First, let's put the coming week into context.
ABOUT LAST WEEK
First, let's put the coming week into context. Last week markets were pulled by essentially two conflicting forces:
- Bullish: hope for official intervention - from the ECB, Fed, and EU aid for Spanish banks.
- Bearish: Bad overall data, evidence of further weakening and China, and disappointment as neither the ECB nor Fed offered hopes of imminent stimulus or rate cuts. Neither one have produced long term benefits, but traders are willing to take a tradable rally for a few weeks, even if these policies make a real recovery more difficult from larger debt loads and potentially bigger defaults.
Overall, hope won out (with some help from technical support) and most risk assets held steady or moved higher.
1. HOW LONG BEFORE MARKETS REALIZE THERE IS NO SPAIN SOLUTION?
The primary factor preventing a massive selloff last week was hope for official intervention. The ECB and Fed disappointed.
That left markets clinging to hope that the EU could stabilize Spain's banks before the June 17 Greek elections and possible contagion threat from a victory by an anti-bailout block that suggests an imminent disorderly default.
What we don't know: how much Spain will get and under what conditions. Spain says it won't know until next week, and that there is a whole list of customary conditions for loans that it wants waived. That's it.
No matter, what we already know is bad enough. There is NO funding as yet lined up for any of the maximum 100 bln euros Spain will request.
- Everyone, Spain and Germany's economic ministers, the Eurogroup, etc, agree that the funding for the rescue is to come from the European Stability Mechanism (ESM) and/or the EFSF.
- The treaty creating the ESM specifically says that the fund can only lend to governments (not banks) in exchange for promises of reforms. The German government has stressed on numerous occasions that it insists that this passage of the treaty is respected. Rumors are that the EU will ease up some of these, but we remain skeptical that Germany will really let these go.
- Yet so far Spain is saying it basically wants doesn't want many obligations attached to the loan. It insists on:
- No loss of sovereignty
- No new fiscal conditions
- No new deficit commitment
- No additional structural reforms
- No IMF supervision
- Even if we somehow get past that disagreement, the ESM treaty has yet to be ratified by most governments including Germany. So forget about the ESM.
- As for the EFSF, it's only got about 200 bln euros, including the now questionable 93 bln due from…Spain! That leaves about 100 bln euros, assuming the EU would agree to empty the EFSF at this time.
- If it did, how would markets react to news that the EU bailout funds are currently empty?
- Wouldn't that news alone be enough to spark panic?
In sum we have no functioning ESM, a woefully underfunded EFSF, and so no clear funding source for Spain thus far, Greece on the edge of the abyss, and the rest of the GIIPS not far behind should credit markets freeze up.
So where will the money come from? The US? In an election year?
We doubt it.
EU Choice: Germany or Money Printing?
That leaves some form of ECB money printing, whatever they actually decide to call it. But would Germany agree to stay in a currency union with the euro at risk of dilution?
Even if all the above hurdles are overcome, holders of Spanish and worse Italian must face the growing risk that precedent of the last Greek bailout will be applied to them- a forced haircut AND having their claims made junior to those of the ECB? That alone could mean Italy needs aid for which there is no funding available.
That brings us to the next, rather related market movers to watch.
2. SIGNS OF DETERIORATION IN ITALY
Unless the EU comes up with a convincing plan to at least buy some time for Spain, expect Italy to come under speculative attack . As noted above, the last Greek bailout gave credit markets every reason to get nervous whenever spiking rates or other default threats appear.
If that happens, the Greek elections rapidly become irrelevant. The entire significance of Greece is that if it becomes insolvent then contagion could spread. In the above scenario, that's already happened.
3. GREEK ELECTION RESULTS
If markets somehow remain calm about Spain and Italy, then markets could well focus back on Greece. Speculation ahead of the June 17 Greek elections could move markets either way. Officially polls are banned, but that won't stop media reports and speculation. The €1.25 billion Greek bill auction Monday could provide clues about how markets feel about Greece.
After these, the remaining market movers are far less scary. Indeed if the above don't spark a selloff in risk assets and the below 3 prove to be the main market movers, it could be a quiet, even mildly positive week.
4. REACTION TO WEEKEND CHINA DATA
On Saturday we got a batch of China data on inflation, fixed asset investment, industrial production and retail sales. The bad news is that most of it missed expectations. The good news is that
- the data was mostly second tier
- was expected to be somewhat weak anyway
- and still shows growth that most of the developed world can only dream about
Our take, if markets realize the gravity of the situation in the EU, this data gets ignored. However if markets somehow take a wait and see attitude about Spain and continue to trust in EU leaders, then perhaps this data pressures markets early in the week.
5. ONGOING SPECULATION ABOUT US QE
While US stimulus has failed to produce genuine recovery while just adding to Washington's already onerous debt load, markets still believe the Fed is ready to engage in more stimulus to at least buy some time to prevent another recession, even if it risks raising the US debt load and branding the Fed as a branch of the Obama reelection campaign.
6. CALENDAR EVENTS
It's a typical late month calendar that's light on top tier events from the leading economies. They will be relevant only if EU contagion fears somehow remain restrained. We don't see how, but markets have shown a remarkable capacity for blind optimism. If calm prevails, the following events might prove market moving, particularly US retail sales and inflation data, especially if these are very positive. Markets remain fearful and technically oversold, so they could bounce on even mildly good news.
UK: Mfg production
Australia: RGA Gov Stevens speaks
US: retail, PPI reports
New Zealand: RBNZ rate statement and press conference
US: CPI, jobless claims
Japan: BoJ rate statement, press conference
EU: ECB President Draghi speaks
US: Prelim UoM consumer sentiment, Empire state mfg index, TIC long term purchases, industrial production
See any good economic calendar for further details, like that found on forexfactory.com.
LESSONS AND RAMIFICATIONS
The short version: if traders continue to believe that EU, Troika, US, and other leaders will ultimately save the day, or at least print up some more money to buy time (possible given their behavior over the prior years and the impending US election), then we could get a continued short term rally. If enough traders agree with my assessment of Spain, then this week gets scary. Fast.
Longer term, it's hard to be anything but bearish until the EU is stabilized. Every major economy is slowing and the EU appears out of options unless a new funding source for the GIIPS appears that isn't concerned about getting repaid, because it won't and everyone knows it.
I'm not even considering the 'fiscal cliff' issues the US faces later this year.
Under the current circumstances, the EZ and Euro as we know them is doomed anyway, the only question is how:
- A wave of sovereign and bank insolvencies, and dissolution? Now? Later?
- A decision to unify the EU banking system, form a central EU bank that serves as lender of last resort, even at a cost of effective loss of sovereignty and a rapidly devalued euro?
The big question for next week is whether markets realize that the Spain situation is no closer to resolution, and if so, does Italy come back under speculative attack, markets tank, etc. With Spain and Italy at risk (Greece now an afterthought as ramifications of Greek insolvency are occurring already in Spain & Italy), that means global officials get very serious very fast.
If markets focus on more stimulus coming from the US, then to the extent markets believe more stimulus is coming, that's good for stocks and gold, bad for the US dollar.
CONCLUSIONS: MORE MONEY PRINTING, YET NEAR TERM DEFLATION
We suspect the odds still favor more attempts to buy time and print money in the EU (with or without Germany) and US, as the preferred alternative to a global depression now.
Deflation or Inflation? Near Term Deflation Risk Greater, Longer Term Inflation Risks Remain
Slowing economies, stagnant incomes and spending, and private sector debt reduction could mean inflation is not an imminent threat in most of the developed world, though it remains so over the longer term. As for those stuck in the GIIPS nations, or even stronger EZ nations, they must consider that their deposits and other cash assets are at increased risk from a variety of potential threats. These include, depending on location:
Longer term devaluation from money printing
Redenomination risk (you wake up to find your account is now in drachmas or other local currency)
What Do You Do?
For cash you need, our ideal currencies to have your liquid assets in or connected to a package of :
- Currencies from fiscally healthier nations (Canada, Norway, Sweden, Singapore)
- Traditional safe havens: CHF, USD, JPY. Note: If the EZ continues to deteriorate the odds rise that safety demand for the CHF overwhelms the SNB, it abandons or lowers its peg to the EUR ,and the CHF soars. Also, despite their deep fundamental weaknesses, the USD and JPY continue to perform well in times of fear.
- Gold/silver related assets: timing harder with these. If deflation these could drop, but as long as money printing remains the long term threat, these are important long term holds. If EU panic worsens, liquidity demand overrides concern over purchasing power and these lose out to safe haven currencies.
For cash not needed, bias reliable income producing assets tied to the above stronger currencies or safe havens.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.