Daily Market Reports | May 21 2010
By Greg Peel
The Dow plunged 376 points or 3.6% while the S&P dropped 3.9% to 1071 and the Nasdaq lost 4.1%. The S&P 500 passed through the 10% “correction” mark last night.
While the last month or so has seen global markets following the plight, and thus the movement of, the euro, that all changed last night. The euro closed 0.3% higher against the US dollar at US$1.2464 but US stock markets had the biggest fall since the “flash crash” of a couple of weeks ago. Nevertheless, this sudden dislocation is not specifically representative of a new phase.
What has now overwhelmed market sentiment is fear of stricter regulation, particularly ill-thought out, knee-jerk regulation.
On the European side of the Atlantic, we have already seen the fall-out from Germany's sudden decision to ban naked short-selling in financial stocks, sovereign bonds and credit default swaps. While the intention here is to stop the rout, markets have been thrown into chaos at a time when fear is extreme. Traders have been forced to buy back short positions, and those shorts need to be reestablished elsewhere. At the moment stock markets are copping the brunt.
At the same time, rumours are constantly flying in Europe that authorities are about to step in to stabilise the euro, meaning “buying” euro. This again occurred last night, so while the euro had opened weaker in the session by around lunch time in New York the short-covering rush began again, sending the euro up on the day.
There are a couple of points to consider here. Firstly, most agree it is in Europe's best interest now to let the euro depreciate. Had the IMF been called in to rescue an independent Greece for example, the first thing it would have done is force a steep devaluation of the drachma. But as Greece is part of the eurozone, and contagion has spread, it is in the ECB's and EU's interest to affect a similar measure. A devalued currency makes European exports cheaper to foreign customers while forcing austerity upon citizens, and thus provides a basis for economic stabilisation.
Secondly, if authorities, meaning the ECB in cooperation with global central banks, want to jump in and buy euro to stabilise the currency they will not do it by stealth. Indeed, they will simply telegraph their intention to the market, and the market will do the rest. The authorities need only stand ready to pump in money if needed. Again last night, the powers that be declared they were not about to step into the market. This supports the above intention, and economists are suggesting some level below US$1.20, perhaps as low as US$1.10, is where intervention will be targeted.
The German government, in the meantime, has a problem that it needs to convince its on parliament and people that the announced E720bn stability fund, to which Germany will be a major contributor, is necessary. Why not just kick Greece out of the eurozone? is the obvious question. And France is now leaning that way.
So last night the German government stepped up the rhetoric, pushing for major reforms of the eurozone rules, the restructuring of struggling members' debt, and on top of it all, a reiteration of the call for a global financial market transaction tax. Aside from this sparking fears in the UK that any changes to EU rules would require a local referendum, this “get tough” on regulations at a time the market is in panic mode is only making the situation worse. There are trillions of dollars out there in the global financial markets and investors have now lost confidence in the integrity of those investments. What might new regulations force upon them? The safest place to be is on the sidelines for now, and that's exactly what's happening.
So the bounce in the euro is not a sign of the situation improving. It is simply a sign of ongoing risk-reversal. Short euro positions are now at risk. In the meantime, the “real” risk indicator – the euro-yen – fell 2.3% last night as the world rushed to reverse yen carry trades. The mix of global currency moves meant the US dollar index was down only slightly at 86.03. It was the carry trade recipient currencies which really copped it. One of those is the Aussie, which in 24 hours has been slapped by 3% to US$0.8164. That is a huge move for a major currency.
But now to the US. Given the bounce in the euro was not a sign of any actual improvement in the situation, Wall Street did not have to follow. But worse still, the regulatory reform fear that has created uncertainty on Wall Street all year really hit a crescendo last night.
First up was the ongoing response to the “flash crash” problem of two weeks ago in which the Dow suddenly fell 1000 points. Forget talk of a “fat finger” – no evidence has been found. The real problem is deemed to have been a lack of coordination of stock market “circuit breakers” amongst competing exchanges. The SEC now wants to impose blanket rules on circuit breakers, halting markets in times of excessive volatility by anything up to five minutes. This has terrified Wall Street because it effectively means the regulators are cutting off market access to traders and investors at the most crucial times.
And then there is the broader financial reform bill. Last night the Senate filibuster was broken, allowing the bill to now be put to the Senate. This required bipartisan support by some Republican senators. Now begins the long process of the House coming up with a bill, and the Senate coming up with a bill, and then the two trying to reach a compromise. Wall Street is very fearful of what level of regulation will be imposed, such as the division of commercial and proprietary operations, strict regulations on derivatives, greater capital requirements for banks, and rules to prevent the “too big to fail” problem.
But what had Wall Street really panicked last night is that nobody knows what might happen. Nobody knows what new regulations may be imposed and what impact those regulations might have on their investments both immediately and in the long term. Until some clarity emerges, whether very strict or less strict, the safest place to be is out of the market. And there was a rush for the exits last night.
Last night was more of an uncertainty capitulation than it was a specific vote on the direction of the global economy.
Commodities were very volatile last night, plunging initially before shorts were covered on the euro rally. The Dow also saw a bounce on the euro rally to be only around 220 points down, but then fear took over again and Wall Street closed on its lows. By that stage commodity markets had closed.
Base metals closed mixed and net moves were not large. Oil was down US$1.86 to US$68.01/bbl on the June delivery contract which expired last night. The new July front month contract fell US$1.68 to US$70.80/bbl.
Gold continued its pull-back , falling US$8.70 to US$1183/oz, but the world rushed US Treasury bonds last night, sending the benchmark ten-year yield plunging 12 basis points to 3.25%.
Lost in the wash was US economic news. The benchmark Philadelphia Fed manufacturing index posted its ninth straight month of gains in May, rising from 20.2 to 21.4. Given recent positive data economists expected the April measurement of the Conference Board's leading economic indicators would rise, but it fell 0.1%. Weekly new jobless claims also jumped last night, not exactly helping the mood.
Overall, it was a simple day of panic.
The SPI Overnight fell 106 points or 2.5%.
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