Daily Market Reports | Apr 29 2010
By Greg Peel
The Dow closed up 53 points or 0.5% while the S&P gained 0.7% to 1191 and the Nasdaq was flat.
With the contagion of debt issues sweeping across Europe, sending the bond yields of stricken nations spiralling upwards, the implied increase in the cost of borrowing means it was inevitable Spain would be next in line for a credit rating downgrade. And so it was Standard & Poor's cut Spain's rating from AA+ to AA last night and put the country on negative watch.
The unfortunate reality in the free market is that these things feed on themselves, and no greater evidence was provided than the rapid demise of US investment banks in 2008. Fear breeds selling, selling blows out credit spreads, ratings agencies downgrade on higher borrowing costs causing fear which in turn causing selling. It's a slippery slope. And in between are the speculative short-sellers egging the whole process on.
The concept is not lost on EU members, who after four months of fannying about in fear of their own electoral backlashes finally acknowledged the gravity of the situation last night and got real. Talk now is of a bail-out package worth 100-120bn euros over three years for Greece, albeit Germany is still very insistent on strict austerity measures, as well it might be.
The major fear is that Greece is quite simply a lost cause and a small shot of adrenalin was only ever going to provide short term relief. The risk is that the only way Greece could avoid default is to restructure its debt, which means bond holders taking a “haircut” down to, say, 80 cents in the dollar of the face value of its bonds on maturity. Were Greece merely a stand-alone issue then such a move would likely be expected anyway, with bondholders simply losing out on a poor risk trade. This is what happened in Dubai.
But Greece is not stand-alone, (a) because it is part of the eurozone and EU and (b) because in today's world interbank lending joins all financial institutions in a complex web of obligation and exposure. Restructure Greek debt and borrowing costs in all of the eurozone would blow out just as they did in the GFC, and we'd be back in 2008 again. The ramifications would resonate across the globe, all the way to, for example, Australian bank funding. Recession in Europe would mean Europeans buying less fridges from China, which means China would need less iron ore. One must not forget that China's biggest export customer is not the US, but Europe.
What should have happened is that the drachma should have collapsed, forcing austerity measures upon Greece by the simple loss of purchasing power. On the flipside, the popular tourist destination would see a new wave of drunken English laughing about the toy money they're spending in Mykonos bars which would help to provide much needed foreign currency.
But there is no drachma, only a euro. While the euro has taken a hit it has not collapsed, for the simple reason money is shifting within the eurozone as well as out of it. German bonds are the safe haven, given Germany is the world's biggest exporter and runs one of the only surpluses in Europe.
Those who remember the movie Master and Commander would recall Russel Crow having to make the difficult decision to cut a crew member loose into the ocean in order to save the ship. It would seem the simple solution is for the EU to cut Greece adrift, leave it to the IMF, and close ranks around the larger economy of Portugal (which incidentally has a hung parliament and thus little chance of passing strict budget cuts) and the much larger economy of Spain (fourth largest in the zone).
But aside from the fact there is no mechanism within the eurozone constitution to do that, the integrity of the EU and the sanctity of the euro would be forever shattered. Thus it is in Germany's interest to do whatever it has to do, and that's why suddenly Angela Merkel is reluctantly springing into action.
Wall Street stumbled its way through the morning session last night, eventually deciding that a downgrade of Spanish debt was a given anyway. It was thus time to turn inward once more.
Last night's raft of earnings reports was largely positive, including from chemical leader Dow Chemical and a couple of large regional banks. Having been trashed on Tuesday, the financial sector bounced back. Aiding the cause was the late evening rejection on Wednesday of the financial reform bill in the Senate, for the third time. While it is a given the Republicans will fight to the death over this one, the necessary concessions implied by yet another rejection was enough to provide added comfort to Wall Street.
Wall Street began to rally in the afternoon ahead of the 2.15pm release of the Fed's latest monetary policy statement. While no one expected a rate rise, Wall Street was thrilled to see “exceptionally low rates for an extended period” being back there in bold – no qualifications, no exit agendas. The assumption is that the European situation can now put a lid on US rate rise speculation for the time being – an assumption being echoed in Australia ahead of next week' RBA decision.
Furthermore, subtle language changes in the Fed statement suggested another quiet upgrade of the US economic forecast. They included a labour market “beginning to improve” and a housing market “edging up”. Still cautious stuff, but slightly more positive nevertheless. Hence Wall Street got the double-whammy: the economy's looking better but forget about rates going up now thanks to Greece.
The Dow was actually up 87 points after the Fed release but late selling crimped the rise, albeit the average managed to hold above 11,000 at 11,045. The S&P 500 mark is yet to recover its 1200 psychological level, while the Nasdaq was no doubt reflecting on the great importance of export markets to tech companies, including that of Europe.
Major currencies largely held their ground last night and the US dollar index dipped slightly to 82.21. The exception was the Aussie, which regained the cent it had lost, to US$0.9254, on some misguided concept inflation was shown to be higher yesterday. The reality is the headline CPI – the one the RBA ignores – rose from 2.1% to 2.9% but the underlying CPI – the one the RBA calculates itself – fell from 3.3% to 3.0%.
Gold slipped US$3.40 to US$1165.00/oz after its big rally yesterday but will likely remain supported while European issues prevail. Base metals remained flat on little change in the US dollar, with the exception of aluminium. Having dropped a huge (for aluminium) 7% on Tuesday the metal recovered close to 3% last night.
Oil clawed back US27c to US$82.74/bbl.
After a tepid auction of two-year notes on Tuesday, the US Treasury would have been pleased with more spirited demand for last night's five year auction. Foreign central banks took 48%, up from the 44% rolling average. The ten-year bond yield nevertheless regained seven basis points last night to 3.76% following Tuesday's big drop and despite little hope of a rate rise.
Despite the 0.7% bounce in the S&P 500, the SPI Overnight managed only a 7 point recovery.
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