Key Market Drivers January 17-21, Trading Ramifications, EU Spring Meltdown?

Key Market Drivers January 17-21, Trading Ramifications, EU Spring Meltdown?

Posted on January 16, 2011 by globalmarketsguide| Leave a comment | Edit

News On EU Debt Crisis, US Earnings Season, and China Tightening Likely To Dominate Market Again This Week, Bullish vs. Bearish Forces,  Ramifications

LAST WEEK JANUARY 10-14

The prior week was dominated by 3 primary market drivers that easily overrode most scheduled economic events outside of US earnings reports. Given that the coming week’s economic calendar is even less potent (again, excluding earnings reports), we expect these same three to dominate next week. First a brief look at the prior week and its lessons for next week.

BULLISH EASING OFSHORT TERM EU ANXIETY OVERRIDES BEARISH CHINA TIGHTENING NEWS

Concern that spiking PIIGS bond rates threatened failed bond auctions for Portugal and Spain was clearly THE dominant market driver this week for all asset classes, so much so that the relatively successful Portuguese and Spanish bond auctions, despite known ECB purchasing to support the bond sales, was enough to overcome continued threats of slowdown in China, the world’s primary growth engine, from further tightening moves and more coming.

The calming came from:

• Relatively successful Portuguese and Spanish bond sales, even though markets knew the ECB was buying  much of the debt

• Reports that EU officials are in serious discussions to create practical long term solutions that could even ease concerns about Spain

• ECB Head Trichet’s hawkish comments suggesting short term rate increases are possible in the coming year despite the widespread economic weakness outside of Germany and France.

• Japan pledges to buy 20% of bonds needed to finance and Ireland rescue

The overall higher close for risk assets like the S&P 500, our favorite risk barometer,  was aided by stellar earnings reports from tech sector leader Intel (INTC),  financial sector bellwether JPMorgan-Chase  (JPM), and promises by Japan and China to help support the EU’s PIIGS bond purchases. The ECB’s Trichet’s mention of inflation concerns, which in turn heightened the chance for ECB rate increases, provided some temporary movement but on reflection few take such comments seriously, as most of the EU would not view rising rates favorably given the widespread weakness outside of Germany and France.

Still, currencies follow interest rate differentials, so even this semi-serious additional hawkishness helped the EUR rise vs. the USD.

NEXT WEEK JANUARY 17-21 SAME DRIVERS LIKELY TO DOMINATEEU CRISIS NEWS AND SENTIMENT REMAINS THE KEY MARKET DRIVER

While US earnings and Chinese data have the potential to move markets if/when the EU is quiet, it’s still the EU sovereign debt and banking crisis (the EU banks hold the sovereign debt) that has the most potential to crash markets and thus the most potential to move them up or down depending on whether the crisis appears to be easing or worsening.

ECOFIN MEETING POTENTIALLY CRUCIAL-THOUGH HISTORY SUGGESTS OTHERWISE

The regular monthly meeting of EU finance ministers Tuesday January 18^th has the most potential to be the primary  fundamental catalyst to send the EUR higher or lower, depending on whether markets see progress or just the usual lost opportunity to do so. Comments from German Fin. Min. Schaeuble on Friday restating Germany’s opposition to so-called Euro-bonds, the most practical long-term resolution to the debt crisis, suggest a higher likelihood for disappointment

However through the entire EU crisis, these meetings have usually not produced market moving news.

THE GERMAN ZEW REPORT TUESDAY, CPI THURSDAY, AND IFO FRIDAY

These might have impact if they prove disappointing, for Germany is expected to be the bright spot in the EU, so the potential lies in the power to disappoint.

As discussed below, bearish factors outweigh bullish ones for the EU and EUR in the medium term. There are simply too many potential trouble spots in the coming months.

US Q4 EARNINGS AND CHINA DATA

If there are no major developments in the EU crisis, either of these could become decisive, depending on which yields the bigger surprise, or if both mutually reinforce a bullish or bearish picture.

US Q4 Earning

The pace of major US earnings announcements picks up next week, indeed the market impact of US earnings season tends to peak in the second to third week, after which the overall picture is clear. See any good earnings calendar like that of Yahoo Finance here for a full listing.

China Reports

China releases a batch important reports Thursday. The CPI y/y and Q4 GDP are the most important as they address both how Chinese growth is faring under China’s shrinking money supply, and whether inflation is slowing in response to moves made thus far (and thus whether much more tightening and threats to growth are coming). Rounding out the growth vs. inflation picture for China, there’s fixed asset investment ytd/y, industrial production y/y, PPI y/y, retail sales y/y, and the National Bureau of Statistics Press Conference.

Inflation Underestimated: While these official numbers could well move markets, it’s worth noting that official inflation figures appear to be serious underestimates. I again refer readers to Mauldin’s newsletter here for the full picture, but a few of the highlights include:

• Minimum wages up over 40% in the past year
• Over the past 2 years Shanghai gas heating costs to homeowners up ~600% , electricity up over 300%

SCHEDULED CALENDAR EVENTS

See separate article:

CONCLUSION

Here’s our take on the key ramifications for coming weeks.

EU CRISIS STILL DOMINATES MARKETS, OUTCOME DEPENDS ON WHICH OF THESE HAPPENS FIRST

It’s widely believed (for example see European bond haircuts are coming )that additional bailouts road and sovereign debt restructurings (i.e. partial defaults) are just a matter of time for both Greece and Ireland.  Forget the EU’s posturing and theories. If a nation can’t pay its current debt load, imposing a greater debt load, even if it buys time, is unlikely to improve the situation unless that country is growing fast enough to build credit market confidence within that time. Growth in the EU, especially among the PIIGS nations, is slowing with austerity measures, so forget that possibility.

Greece is already asking for additional debt payment extensions and markets are pricing in a default within the coming years

Ireland faces new elections that could well bring in a new coalition with a mandate to repudiate Irish bank guarantees. Rather than repeat why, see John Mauldin’s thoughts on the matter here.

In essence, the outcome of the EU crisis now depends on which of two things happens first. Either:

1. The EU comes up with a credible bailout plan and enough money or money printing to back it up,  so that credit markets believe that EU even can bailout Spain, which has a GDP and debt about twice that of Greece, Ireland, and Portugal combined, and do so without the bondholders (aka large EU banks) taking any kind of significant loss from restructuring or outright default.

1. One or more of the PIIGS approaches default or serious restructure, before such mechanisms are in place, thus shutting the others out of credit markets by guilt via association, sparking a new crisis that threatens to drag down the whole EU.

The likely deadline is spring 2011, at which point:

• Spain and other PIIGS begin a serious round of new bound sales nearing about $1 trillion.  If their bond yields continue higher that will become complicated if not impossible without another huge bailout fund, which may or may not be ready. Anything less than certainty about that crashes the markets.
• Ireland is likely to see a new government elected on a promise to restructure or cancel it’s sovereign debt obligations

The Balance of Bullish and Bearish Forces

Bullish

• Official willingness globally to intervene to keep markets stable, including ongoing QE in the US and expanding bailout funds in the EU.

• Remarkable market resilience: Markets have managed to hit multi-year highs despite considerable headwinds including:

• US: Moderate growth at best, and a blossoming state and municipal debt crisis in addition to current jobs and housing woes

• EU: Numerous potential trouble spots, just some of which noted above

• Asia: China inflation and slowdown, and a brewing local debt problem (see here for more)

• From a technical perspective, the weekly S&P 500 Chart shows great momentum and no notable resistance until the 1320 area.

S&P 500 WEEKLY CHART: breaking through resistance

09jan16 05

Bearish

• The above noted headwinds

• Markets are at multi-year highs and thus vulnerable to a pullback without significant new good news

• Multiple signs that risk assets are overvalued (see here and here for details)

What That Means For the Markets in General and the EURUSD

The near term trend is risk appetite is up, and it’s pointless to fight that trend until we get some signs of reversal. That uptrend in risk appetite is supportive of a higher EURUSD.

However, as noted above, there are a lot of bad things that can happen to the EUR in particular in the coming months, and it has bounced higher very quickly on nothing more than some hope of better times.

As I’ve noted in repeated tweets and comments all week, we’ve avoided shorting the EUR this past week given that it was obvious there would be official attempts that would come to ensure that the Portugal and Spain bond sales went well. We took a small short EURUSD position toward the end of Friday.

We view the current bounce higher as a setup for another short, and  continue to await a break higher for the EURUSD into the 1.3600 zone +/- 50 pips as an opportunity to establish new shorts for an expected medium-term decline back to at least recent lows. However we first wait for reversal signs and confirmation before committing much to that short position.

When that happens, expect the USD to move higher, stocks, commodities, and risk currencies like the AUD to pull back.

DISCLOSURE & DISCLAIMER: AUTHOR IS SHORT THE EUR, LONG THE CAD, AUD AND USD,  LONG SELECTED EQUITIES HELD AS LONG TERM INCOME/GROWTH INVESTMENTS, SHORT THE OVERALL STOCK MARKET FOR HIS PERSONAL PORTFOLIO. THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY AND NOT TO BE CONSTRUED AS SPECIFIC TRADING ADVICE. RESPONSIBILITY FOR TRADE DECISIONS IS SOLELY WITH THE READER