A brief weekly strategy guide for investors and traders of all markets and instruments, spot market, ETF, and binary options.
- Markets Awaiting Central Bank Salvation 3 Reasons They Could Be Disappointed
- What To Do
There was little for markets to grasp onto this week for discerning new direction.
- The EU crisis was, on the surface, dormant and produced no attention grabbing headlines
- The economic calendar had little in the way of top tier data from the regions that produce the really market moving news: the US, Europe, and China.
- Earnings season's influence is largely spent and the tone is set: mixed results despite low-balled estimates
- The financial sector is firmly settled into summer vacation mode, and so inclined to do little unless events force its hand
Given the lack of market moving events this week, markets instead moved with sheer speculation about prospects for new stimulus from the most important central banks, the Fed, ECB, and PBoC.
3 REASONS THESE EXPECTATIONS COULD DISAPPOINT
Here's why we're skeptical.
1. The ECB: Realmente, Mario, What Can You Actually Do?
The ECB is at the heart of the EU crisis, and that arguably makes markets uniquely sensitive to its actions as they most directly impact this most significant threat to the global economy and financial system.
Nearly three weeks ago, ECB President Mario Draghi single handedly sent markets and the EUR rallying when he pledged to do whatever was needed to protect the EU and Euro. His comments were widely interpreted to mean that some kind of virtual EU-wide guarantee of GIIPS bonds and rates was coming, regardless of whether in the form of Eurobonds, GIIPS bond purchases, or some other variation.
Of course, adding more debt of dubious quality to the EU banking system is hardly a long term solution and worse, risks making the ultimate default that much worse. Still, anything that pushes off the imminent threat of an EU collapse and contagion (at lease long enough for a multi-week tradable rally fueled by frantic short covering) passes for good news these days.
While the much anticipated announcement of big moves at last week's ECB meeting never came, Draghi raised expectations for the big new policy initiative to be announced at the ECB's September meeting.
Specifically, what fed these expectations were the following remarks:
The Governing Council, within its mandate to maintain price stability over the medium term and in observance of its independence in determining monetary policy, may undertake outright open market operations of a size adequate to reach its objective.
In other words, the ECB may make huge bond purchases to drive yields lower.
In addition, Draghi then said:
Furthermore, the Governing Council may consider undertaking further non-standard monetary policy measures according to what is required to repair monetary policy transmission. Over the coming weeks, we will design the appropriate modalities for such policy measures.
That is, more time was needed to work out details, but action was still coming. The rest of the press conference suggested that the focus will be to lower short term yields, which somehow pleased market though of course solves nothing except that perhaps it buys some time.
Again, to distinguish real from false solutions, we refer readers to last week's handy checklist in 7 Criteria For Distinguishing Real Eu Crisis Solutions From Fakes. So far we see nothing but moves that buy some time (condition #4 on our list), at the expense of making other needed conditions worse, not better. EU is now in worse shape. Each week without progress means it's that much closer to the next crisis and still has its pants down by its ankles.
In sum, Draghi has simply deferred hopes for salvation for a few weeks until the September ECB meeting.
As noted in the past, we're not sure how much he can really do as long as German opposition stands fast again mutualization of debt or assorted forms of money printing, and the bailout funds are inadequate. The EFSF is underfunded, the ESM isn't likely to exist for months, and its powers and funding are as yet unknown. So what can the ECB really do? Allow more borrowing at low rates to nations that can't handle ANY more debt? So far that's been the basic tool in one form or another.
Although the markets have continued to give Draghi the benefit of the doubt most of the time this past week, if he again disappoints in September, markets may be far less forgiving. Remember, August is vacation time for the financial sector heads, and so there's a certain bias to maintaining the status quo while the bosses are away.
However September and October are associated with some nasty market plunges, and markets again turn serious, so they may be far less forgiving of the EU and EUR if Mario again disappoints.
2. The Fed: The Facts Argue Against New Stimulus Soon
Many continue to believe that the Fed is soon due for a new round of some form of easing/money printing is due despite a batch of evidence to the contrary, including:
- US beating GDP, NFP forecasts, suggesting the US economy is not yet in the dire shape needed to justify new spending
- It's unclear that prior stimulus has had any long term benefit, while its costs have included
- a higher deficit
- a longer term risk of inflation from the added cash sloshing around the economy when things do improve
- a deterioration in the balance sheets of pension funds and households from inability to find yields for their cash hordes that were anticipated for funding future needs. Witness the growing list of bankrupt municipalities from underfunded pensions
- As we've noted repeatedly, when all sectors need to cut debt and are doing so (except for large swaths of the public sector including the Federal government), and banks are more cautious about lending as they rebuild their balance sheets, cutting borrowing costs will have only limited effects as relatively few seek to borrow or lend.
Recent Fed stimulus hopes were raised by Boston Fed President Rosengren's remarks this past Tuesday.
The only likely scenario for new aggressive easing would be if the global economy received some huge shock that threatened the still fragile US recovery. The most likely source of such a shock would be from a new imminent default and contagion threat from the EU, most likely from Spain or Italy. It's unclear whether Greece alone could be a catalyst for an EU wide contagion that threatens to spread beyond the EU. Sudden hostilities involving Iran and the flow of oil or really bad news out of China might also qualify as justifying desperate means from the Fed.
3. The PBOC: Stimulus Hopes Produce "Bad News = Good News" Effect
Worsening retail, industrial, fixed asset and trade data from China last week, along with declining producer prices, fed expectations for coming easing from China's central bank.
Essentially we've the same story here as seen above. New stimulus could well produce short term rallies. However if China's primary export markets mentioned above are stagnant or declining, the affects are likely to be temporary.
Conclusions & Ramifications
So what are the key lessons, and what do we actually do?
3 Key Lessons
The key lessons from the prior week are:
- Markets don't expect real self sustaining growth, so instead they're willing to settle for temporary measures imposed from above, even if they come at the risk of higher government spending, debt loads, more bad bonds sitting on ECB and other TBTF EU banks balance sheets that raise contagion risk, etc. The mere fact that markets are rising on such prospects of more, irresponsible long term policy strikes me as disturbing. As noted these hopes could well be disappointed, and even if met in the short term, will likely disappoint in the longer term.
- The quiet, low volume range bound nature of most asset markets suggests a typical late summer tendency to have quiet range bound trade as the financial sector's bosses rotate off on vacations, leaving their subordinates inclined to do little unless events force their hands.
- Risk Assets Back Near Multi-Year Highs From September 2011 Lows: Note the S&P 500 Monthly Chart below ( as good a long term risk appetite barometer as any). Does this suggest resilience or simply that we're nearing the end of the latest counter move higher since the start of the latest leg in the secular bear market that began in late 2007? We suspect the latter, barring an unlikely breakthrough in the EU.
S&P 500 MONTHLY CHART AUGUST 2002 TO AUGUST 10, 2012
Source: MetaQuotes Software Corp, thesensibleguidetoforex.com
01 aug 12 0022
What To Do?
So what do we do based on the above?
Short Term Outlook
With decisions on Spain and Greece apparently deferred until September, barring any surprises the coming weeks are likely to produce more range bound action suitable for selected short term trading by qualified short term traders only. The rest should simply monitor markets in case any nasty surprises arise, and otherwise use the time to take a break with the rest of the financial sector and get rested up for September and October, which could well fulfill their reputation for being treacherous as decisions on Spain, Greece, and other key EU issues are confronted.
Longer Term Outlook
Our long term outlook (multi-week to months) remains firmly bearish. For longer term positions we wait to see how far this tepid August rally goes and plan short entries for risk currencies and other risk assets for when markets get back to work in September. In particular we wait to establish new shorts in indexes and the EURUSD and other risk currency pairs.
As for gold, the big question is whether we're heading for stimulus that dilutes currency buying power (good for gold and other currency hedges) or a bout of financial panic, which would hurt these assets and favor safe haven currencies and their safer bonds.
With bonds overbought and producing low yields, those who must deploy cash that isn't likely to be needed might consider quality income stocks that throw off income in CAD, NOK, and other currencies backed by relatively healthy banking systems and national balance sheets.Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.