The Biggest News Was What Didn't Happen, Why, And Its Implications
There were three primary market moving events for the week ended Friday August 3rd, 2012. First, here's a quick look at the two that actually got covered in the mainstream press. Then we'll end with the really big story from Friday, whose real impact is likely to be felt more in the weeks ahead
1. Speculation On Fed, ECB Actions
Until US jobs reports came out on Friday, the dominant market mover was daily market sentiment about what these 2 central banks would do to help two of the largest economic regions. After the recent US GDP beat eliminated chances for significant new stimulus, hopes mostly focused on the ECB after Draghi's comments last week were taken to mean coming GIIPS bond purchases.
Markets were up when they believed the ECB would take major action, down when they thought it wouldn't. Draghi's remarks disappointed and drove markets lower Thursday, but then on Friday some noted positives, particularly hints that the ECB might give up its seniority over other sovereign bondholders, which in theory should reduce risk premium on these and lower yields, now that the ECB would no longer step in front of other creditors in the event of any sovereign default.
Of course, more bond purchases will solve nothing in the long run, and likely make any ultimate EU contagion worse because there would be that much more bad debt, but it would buy some time. That alone is worth at least a short term rally.
Draghi in fact did virtually nothing, which pounded risk asset markets Thursday. However by Friday investors saw some potential positives in Draghi's remarks, which helped send markets higher. These included:
Emphasis on the Euro's permanence and that debts and bank accounts will not be re-denominated into local currencies (although that will ultimately not be an ECB decision, but one for the states themselves). Apparently there are those who still believe the ECB, despite its recent behavior. See section 3 below for the latest reason not to trust anything the ECB says.
Saying that issues of the ECB's seniority over other sovereign bondholders, which raises the risks of holding these bonds and thus helps keep their yields too high, would be "addressed." Hopes that the ECB might waive its seniority would be lower risks and yields on GIIPS and other EZ member sovereign and bank bonds.
2. US Jobs Reports
Markets focused on the overall positive data.
- Non-farms payrolls up 160K vs. 100-120K consensus, outweighing the downward revision of the prior month and thus showing an overall gain in jobs.
- Unemployment rate up from 8.2 to 8.3, but the rise was not as bad as appears as the increase came from a rounding error, and
- Private payrolls shot up 171K vs. the 110K forecasted
However there were distinct negative aspects of the report.
The broader U-6 jobs data which includes discouraged and underemployed rose from 14.9% to 15%.
Last month's NFP report was revised lower. While the current month figures outweigh the loss from the prior month downward revision, that revision suggests that the report data is not current but reflecting outdated conditions. Is this report also overstated and due for a lower revision?
For those who believe the only hope for risk assets is more QE, the report was negative because in combination with the Q2 GDP beat, it showed the US isn't in deep enough trouble for the Fed to consider new stimulus anytime soon.
David Rosenberg points out additional negatives, primary of which are:
- Compared to the 220k new jobs one would expect in the third year of a recovery, the 163k "beat" looks much less auspicious
- Average hours and wages worked remain essentially stagnant, y/y hourly earnings are actually down, so it's hard to see how this signifies any material gain in consumer spending, which is what's really needed for a sustainable recovery
- The household survey (from which the unemployment rate figure is derived) was awful, showing 195k full time jobs lost. Admittedly this figure is based on a much smaller sample and so is more volatile. However it does a better job of capturing small business and farm employment, whereas the NFP figure is based on a survey of large corporations only.
See here for more on the differences between NFP and employment rate calculations.
3. Biggest Market Mover: ECB Backtracks, Prevents Selloff
On July 20th the ECB stopped accepting worthless Greek bonds as eligible ECB collateral.
Once again, Greece faced insolvency if it made its early August bond payment to the ECB.
Once again, despite threats to let Greece go bankrupt, the ECB ignored its own better judgment, ignored the aforementioned ruling and essentially released more cash for Greece by raising the upper limit of (junk rated) short term debt the Bank of Greece can accept as collateral in exchange for emergency loans to keep insolvent Greek banks on life support.
The immediate reason for the latest crisis was that the Troika has delayed its decision on how to respond to Greek noncompliance until September, but meanwhile is withholding further cash disbursements.
See here for full gory details.
The story received little attention, but had the ECB held firm, Greece would be facing insolvency in the coming weeks and markets would be in full crisis mode.
While ultimate Greek default is widely assumed, we see little evidence that it's priced into markets, given that (looking at just 2 minor details):
- Major risk asset barometers like the S&P 500 remain locked in a relatively tight trading range since the start of the year, and are far closer to their multi-year highs (nearly 1600 in 2007 and over 1400 earlier this year) than their March 2009 lows (650).
- Yet, actual indirect third party liabilities are not well known by most traders, meaning if Greece gets ready to die, markets will likely sell first and ask questions later, interbank lending could again freeze up, etc.)
These alone suggest plenty of potential for a dramatic plunge. Once traders start feeling negative, then don't forget that they may also note the approach of the as yet unresolved US fiscal cliff issues for more uncertainty towards the end of the year. If so, that would further fuel the selloff.
In sum, regardless of the long term consequences, the ECB likely prevented a huge selloff either Friday or early this week.
Markets closed slightly higher based on a mixture of:
- Hope that central banks will save them, rather than any growing hopes for actual, real growth
- A slightly positive US monthly jobs report which did nothing more than continue the theme of a fragile, anemic US recovery that's vulnerable to any shocks, be they from the EU crisis, a China slowdown, or the coming fiscal cliff.
- Yet most risk asset markets remain far closer to multi year highs than lows.
This remains a market for short term traders or those shorting risk assets if willing to bear the risk and volatility from further possible government and central bank interventions
For longer term investors, the USD and other safe haven assets in USD remain the best of a bad lot, as the USD's natural competitors, the JPY and CHF, are being undermined by their own central banks for the sake of helping their domestic exporters.
Ironically, BofA reported that the extreme bearish sentiment for risk assets is a huge buy signal. This is no more trustworthy than their mortgage department's ability to transfer good title or follow sound procedures.
- First, sentiment indicators are notoriously unreliable, especially for timing market changes
- As noted above, risk assets are not cheap by any standard, and the global market is faced with multiple serious threats, including slowdown in China and collapse in the EU both quite conceivable.
A Key Lesson
Again, we close with a reminder that one of the most likely end results of all this is that the most widely held currencies will be printed heavily, savers be damned, as nations fight of depression threats. Anyone with most of their assets denominated in any of the most widely held currencies needs to diversify into assets tied to currencies with better long term prospects.
Disclosure /disclaimer: The Above Is For Informational Purposes Only, Responsibility For All Trading Decisions Lies Solely With The Reader.