Daily Market Reports | May 11 2010
By Greg Peel
The Dow rallied 404 points or 3.9% while the S&P 500 jumped back 4.4% to 1159 and the always more volatile Nasdaq leapt 4.8%.
Australia had the first opportunity to respond to the various announcements emanating from Brussels on Sunday night European time regarding a euro defence fund worth some E720bn. For details of the responses from the EU, ECB and global central banks see Europe Scrambles The (Financial) Troops published yesterday.
The 2.5% rally in the ASX 200 was accompanied by a 1.6% rally in Japan and 2.5% in Hong Kong, but unsurprisingly it was Europe itself which exhibited the greatest amount of relief. London was up 5.2% and Germany 5.3% while France and Belgium added more than 9%, Italy and Portugal 11%, and the winner was Spain with 14%.
The scene was thus set for a follow-through on Wall Street, and with ultimate NYSE volume at 1.8bn shares there were plenty of players. However, but for the immediate price adjustments after the opening bell, Wall Street was flat all day. The Dow was up 400 points at the open and 400 points at the close with minimal movement in between.
In S&P 500 terms, the market pushed only back to its 200-day moving average – the level which, once broken last week, sparked accelerated selling. That level has now effectively become resistance. Yes – the euro has in theory been “saved”, but only in the sense it won't be permitted by global central banks to collapse in a panic. Wall Street on the other hand, and notwithstanding the problems since created by Thursday's exchange system breakdown, has had a reality check. The VIX volatility index tells the story. Last month it dropped to 15, which can only be considered as “very complacent”. Last week it peaked at 40 which is traditionally (not counting the Lehman collapse) as high as it usually gets in panic, and last night it retreated 30% to 28 – no longer suggesting “panic” but now suggesting a sensible demand for fire insurance.
One might suggest that for all of last night's session on Wall Street there was an uneasy feeling of “now what?” rather than any euphoric belief that the war is over. And the euro told the tale. It is well known that short positions in the euro are as heavy as they have ever been, so Sunday night's announcement was always going to spark a short-covering rally. The euro bounced rapidly from having stared at US$1.25 to be back at US$1.31 in the scramble. But that was it. When the dust settled, the euro began drifting back again, all the way to just under US$1.28.
What does this tell us? Has this defence fund failed?
Well for starters, we do have to consider the political implications of the specific E440bn guarantee announced by EU finance ministers. Although this is just a guarantee and not a loan, it is four times larger than the E110bn Greek rescue package. That package had to be ratified by all EU parliaments and for a while there it looked like it would fail in Germany. The German opposition leader nevertheless came to the party, but only after German banks agreed to be part of the rescue consortium.
That package was passed in the German parliament on Friday – a good couple of months after it was first touted. On Sunday, Angela Merkel's party lost a state election and with it control of the German upper house. Now the EU parliaments have to ratify this E440bn package and the most important member has a hostile senate.
Assuming the German parliament is won over, what have we got? We have a guarantee from the EU, ECB and global central banks to “defend” the euro. Not to attack the US dollar, just defend the euro. In other words, the euro has a floor price now but there is no incentive at all to actually buy it. Europe will now fall into the deflationary doldrums of extended weak economic growth. The EU has moved to de-base the euro, which will effectively be achieved by “printing” fresh euros. This monetary inflation will balance inevitable CPI deflation.
So why would you buy the euro? There's going to be a lot more of them floating around and little in the way of GDP growth to support them. Commentary from Wall Street today suggests the euro will continue to weaken, at least to US$1.25 and then eventually lower, albeit controlled by central bank dampeners.
The failure of the euro to go on with it last night had Wall Street nervous, 400 point rallies aside. Life cannot quite go back to where it was – all sweetness and light with improving US earnings and economic data – without the shadow of a disabled Europe in the background. Forget not that Europe is a very big consumer of global wares. Forget not that China's biggest customer is not the US, as one might assume, but Europe.
That is not to say we are going back to 2008. It's just that the world has come to realise you don't just recover from a GFC as quickly as it might have appeared. History tells us this anyway. With more money being pumped into the credit system, stocks and commodities can again rally, but this time the rallies will be a bit more measured.
The flight to quality which was the feature of last week was not simply reversed last night. The US dollar still rallied against the yen indicating no re-establishment of carry trades. The euro did not rally (net) so the dollar index fell only marginally to 84.27. It did not drop rapidly as it might during an unwinding of a flight to quality.
Gold fell only US$5.30 to US$1202.70/oz which again shows no real flight out of quality, and no doubt reflects another round of global fiat currency inflation.
Base metals bounced as one might expect, but only 2-3% across the board. Oil similarly rose 2.3% or US$1.69 to US$76.80/bbl. Only the Aussie showed any real sign of rebound, rising one and a half cents to US$0.9030. The Canadian dollar found similar support, highlighting that the commodity currencies are still a safe place to be in a world which is shifting focus from West to East.
US Treasury bonds also saw a flight out of quality nevertheless, with the benchmark ten-year yield jumping 11 basis points to 3.53%. the flipside of that trade were all those Southern European bonds which saw very big contractions in their risk spreads overnight. This reflects the ECB's intention to now start buying up that paper as part of the general eurozone rescue effort.
As a last word on that EU rescue package, caretaker Chancellor of the Exchequer in the UK Alistair Darling spoke smugly on television last night about how the eurozone was not the UK's problem, and how any UK support would be minimal and merely requisite as an EU member. Darling is thus lame, and not just in duck terms. I wouldn't want to be the UK now, looking for support from the EU some time down the track.
The SPI Overnight added 58 points or 1.3%. Put that on top of yesterday's 2.5% rally in the ASX 200 and you have 3.8% (roughly) which basically matches Wall Street.
The fun is not over yet for Australia however. Today we see the bulk of China's monthly economic data, which will provide another insight into China's economic growth or tightened lack thereof. And tonight the Federal Budget is brought down, and who knows what the Rudd government has cooked up to add on to the Henry proposals to date.
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