- Fear Trumps All Else -EU Debt Crisis & Contagion Fear Related Credit Market Developments
- China Cooling
- UK Political Situation Clarifying
- Key Economic Calendar Events:
The Big Trend Depends On The EU Steps To Restart Interbank Lending
Barring major EU steps to ease liquidity and concerns about risks to European banks from a lack of interbank lending (on uncertainty about which banks are overexposed to a Greek or other PIIGS block bond default), more downside is ahead.
At best markets might manage to stabilize in the near term. If not, we expect more downside this week, and in any case see March 2009 lows as a likely target in the coming months until credit markets show signs of stability.
That means USD, JPY denominated AAA bonds and cash remain the safest near term bets.
If the EU does manage serious new QE steps to prevent bank failures in the wake of possible PIIGS bonds defaults, markets would bounce. So should the Euro, despite the new money printing, as a devalued Euro is still better than an extinct Euro.INTRODUCTION
What a difference a week makes.
At the open Monday, most equity and other risk asset markets remained close to 52 week highs, despite serious fundamental and technical red flags. See Coming Week Market Drivers May 2nd-7th: EU Crashes Markets and Ramifications for details on these.
As of this Friday’s close, despite the best monthly US jobs report in years (lesser reports last year were able to send markets rallying):
- Most risk assets have suffered their steepest losses in well over a year, and are now testing the normally very strong support of their 200 day moving averages.
- Daily and weekly charts of most major equities indices, oil, and risk currencies (vs. the USD and JPY) show the same amazing story:
- Friday closing prices violating uptrend lines stretching back to March 2009.
- The worst weekly losses since March 2009
The bellwether S&P 500 index finished the week down 8.7%, its worst loss in well over a year, reminiscent of the last market collapses in the late 2008 and early 2009. Overall stocks were down about 6% on the week.Market Recap
Over a week ago in The Coming Crash: Four Reasons Pro and Con we noted in that bullish and bearish forces to watch were arrayed as follows:
Four Primary Bullish Forces Keeping Markets Afloat
- Low interest rates:
- Slowly but steadily improving economic data and earnings
- Growth in emerging markets
- State Economic Creativity
If the above forces prevail, given the bearish clouds hanging over markets discussed below, the best case scenario appears to be perhaps a bit more upside at most, with markets stagnating but not collapsing through 2011.
Four Horsemen Of The Coming Crash
When it comes, one or more of these will bring it. (see The Coming Crash: Four Reasons Pro and Con ) for details on these
- EU Debt Crisis: A likely wave of sovereign defaults and resulting bank failure contagion that has likely become a question of when, not if.
- US Subprime Crisis II:
- China- Slowdown or Crash? (Andy Wie Will Tell You When Chinese Bubble Is About to Burst ).
…and if the markets are still standing…
- Rising Interest Rates: Either via central banks promised tightening short term rates or bond markets raising long term rates on fears of rising default risk from rising deficits.
See The Coming Crash: Four Reasons Pro and Con for details.
As we’ve argued for many months, it was a matter of when, not if, the EU crisis would become a global one if left untreated. It wasn’t, at least not in a way that convinced anyone that there would either be no PIIGS defaults or that if there were, there would be no major bank defaults as a result.
This week it hit. The process appears to have begun in earnest, with the four horsemen of the coming crash led by the EU Debt Crisis.Key Questions And Answers For The Coming Weeks
What caused the collapse? What changed?
What are the key forces to watch for determining how much further the pullback will go?
Fear Of European Credit and Banking Collapse: EU banks had stopped overnight lending to each other on uncertainties about which banks had dangerously high Greek bond exposure. About a fifth of European bank assets are funded via this overnight lending, making this collapsing of short term credit an immediate threat of becoming the feared credit markets seizure that followed the Lehman Brothers collapse in September 2008. THIS IS THE MOST COMPELLING REASON. Why did it happen now?
- CONTINUED political opposition in both Greece and donor countries to the current bailout: The European banks see growing risk that Greece won’t get funding in time to avoid default in the coming weeks
- CONTINUED EU failure to address concerns about the other PIIGS nations that like Greece, may be driven into default by spiking borrowing costs.
Here lies the answer to both of the above central questions for the coming weeks. The fate of markets in the coming weeks depends mostly on whether they see that either:
- 1a And 1b Will Be Resolved: On Friday there was a rumor that this weekend the ECB would announce a €600 bln credit facility to support Euro-zone banks. Something of that magnitude is needed.
- At Minimum, An EU Resolve To Prevent Bank Big Bank Failure In Case of PIIGS Bond Defaults: That would at least restore overnight interbank lending and ease concerns about an EU banking crisis similar to that seen after the Lehman Brothers collapse in the US.
Other contributing factors:
- A spiking unwinding of JPY carry trades signaling panic in forex markets
- Programmed trading systems of large institutions gone mad “feeding off each others' signals and resulting in a crazed feedback loop of selling.” (More on the Crash, Possible Triggers and High Frequency Trading).
- There is an as yet unconfirmed rumor that a trader at Citicorp mistyped a trade as $15 billion instead of the intended $15 million.
The prime fear agent - the EU crisis - was clearly already out of control after last week’s latest expanded EU/IMF failure to calm markets (see The Seven Deadly Questions Killing The Euro And Global Markets ), in the face of continued serious political opposition both within Greece and donor countries.
So fear hung over markets like gas fumes needing just a spark. Markets were ripe for a panic driven pullback regardless of computer or human error, both of which have happened before without such consequences.
Precise timing of the start was anyone’s guess.Key Market Drivers This Week
EU Debt Crisis Events
- May 9th
- German Regional Elections: A defeat for Merkel’s party will cast doubt on German resolve and may well confirm the credit market’s view that Greece will eventually default, making any rescue in the coming weeks less likely as potential donors lose motivation to throw good money after bad.
- EU Policy Makers’ Statement After Weekend Conference Calls, Monday Finance Ministers’ Meeting: Expect some attempt to talk up confidence. However, anything less than a major attempt at restoring liquidity like new QE measures that shocks markets is unlikely to have lasting effects.
- German Legal Challenge to Greek Aid: Four German professors are due to file a complaint with the Constitutional Court. The Court will likely announce whether or not the lawsuit will be accepted at the start of this week.
- CDS Spreads: Italy needs to issue €30 bln of bonds in June, Spain a similar amount in July. Watch costs of insuring against default on their bonds, also those of Portugal. It is considered the next most vulnerable to default after Greece.
UK coalition ambiguity has pressured the Pound. Any news that removes uncertainty should lift the GBPChina Cooling Data
Watch for more on Chinese attempts to cool its economy. Data pro or con likely to influence the fading AUD. Scheduled data includes Trade data due Monday, Producer prices, retail sales and industrial production Tuesday.Other Key Economic Events
If both US Earnings and Monthly Jobs reports are crowded out by EU debt contagion concerns, we don’t expect economic calendar events this week to be any more influential.
- US: Friday retail sales could confirm or neutralize the overall positive US jobs reports this past Friday, which soundly beat estimates. While the unemployment rate rose, that was attributed to increasing numbers of newly encouraged workers seeking work, and if so is a positive sign. Jobs and spending are the key metrics the Fed is using for timing rate increases, so good retail numbers are likely feed the USD rally as its underlying fundamentals look to have more upside in the coming months than most other currencies.
- EU: Monday May reveal further moves to aid Greece, as may a Foreign Ministers Meeting. Friday Greece submits its deficit reduction progress report to the EU. While positive surprises may not matter much, negative ones could further confirm the default thesis and further rock credit markets.
- UK: Monday BoE rate statement, retail sales
- Japan: Wednesday leading indicators, trade balance
- Canada: Monday housing starts, Wednesday new home prices and international trade, Friday manufacturing sales.
- Australia: Wednesday home loans, Thursday jobs report
- New Zealand: Wednesday business PMI, Thursday retail sales
DISCLOSURE: NO POSITIONS