Daily Market Reports | May 20 2010
By Greg Peel
The Dow closed down 66 points or 0.6% while the S&P lost 0.5% to 1115 and the Nasdaq fell 0.8%.
It was another night of excessive volatility in offshore markets last night, brought about by Germany's sudden ban on naked short-selling. While the movement of the goal posts mid-game has angered traders across the globe, market responses affected another rollercoaster ride. Obviously, where goes the euro goes everything at present.
Late on Tuesday, Germany announced a ban on the naked short-selling of ten major financial stocks, European bonds and credit default swaps (CDS). What this means is you can't short-sell a bank stock unless you borrow the stock first, you can't short-sell a bond unless you borrow that bond first, and you can't buy a credit default swap (which effectively means going short) on a bond unless you own that bond.
The move is not dissimilar to emergency measures taken across the globe in the wake of the Lehman collapse. At that time, most major stock market regulators, including Australia's, banned short-selling of bank stocks altogether. In Australia's case, the ban was eventually lifted but the rules on “naked” short-selling remain. (They were always in place, but not well monitored previously. They have been tightened up since 2008).
While free market purists would argue quite stringently otherwise, most in the market appreciate that naked short-selling – selling stocks you don't own and have not borrowed first – is indeed a destructive and largely “unfair” practice. I believe nevertheless this is the first time naked bond selling and naked CDS buying has been banned. This move comes ahead of the global intention to introduce rules for previously unregulated CDS markets anyway, but there has been parliamentary resistance on that front. When the dust settles the case will be argued either way, but as I noted it was the out-of-the-blue timing of Germany's announcement which caught out and angered traders.
The initial response was “Well if we can't sell stocks and bonds we'll just have to sell the euro”. And so they did last night, down to a four-year low of US$1.2143. But there is one little flaw in that plan. Obviously there were plenty of traders who had to reverse bond shorts and sell CDSs, as well as bank stocks. If they are foreigners, they need to buy euro to do so. So suddenly the euro turned around.
Possibly triggering the turnaround as well is the fact the euro had now reached roughly the 50% retracement point of the rise from US$0.82 in 2000 to US$1.60 in 2008. And there were also rumours speculating that authorities would now step in to stabilise the currency, although they were no more than speculative. But once the bounce began, those traders short the euro suddenly found themselves in a “short squeeze”. Stop-loss orders were triggered, and the euro rocketed back up to US$1.2409. This meant selling US dollars, so the dollar index was down 1.3% to 86.15. It also meant selling yen, so the euro-yen also recovered.
But if you are forced to buy back your yen but you also want to unwind your risky carry trades, what do you sell to compensate? You sell out of one of the most popular carry trade currencies – the Aussie. Last night the Aussie plunged nearly two cents to US$0.8433 as carry traders rushed to buy back yen shorts.
But as has been the case for the past couple of weeks, Wall Street was in lock-step with the euro last night. As the euro fell the Dow fell to be down 186 points at midday, and as the euro bounced the Dow bounced back to be down only 66 points at the close.
There was no such recovery in European stock markets however, which missed the bulk of the euro bounce. And if you're forced to buy back banks and bonds you have to sell something else. Germany was down 2.7%, France 2.9% and London 2.8%.
I am a bit confused this morning because I can find no news of the E18.5bn Greek debt rollover. I can only assume it was simply covered by the money which was handed over this week from the EU emergency fund. Portugal managed to put away a E550m bill auction last night without much trouble, and tonight there is an auction of Spanish ten-years. In the meantime, the ECB balance sheet is under pressure as the central bank buys up Greek and other sovereign debt issues. Many in the market still believe Greece will default, which would prove very costly for the ECB.
Last night the Greek prime minister denied all rumours Greece would look to exit the eurozone.
So sort your way through all that mess. I noted earlier that if you are forced to buy back positions you have to sell something, and gold took a hit last night. Gold was down US$32.30 to US$1191.40/oz. The selling in gold was probably also representative of a tipping point given the safe haven metal has failed for the past few days to break up past the previous high. Late speculative buyers may well have thrown in the towel. And rumours of official support for the euro entering the market is another potential trigger.
Base metals were also hit again in London, having responded to the bulk of the euro's initial fall. Copper and nickel were down 2% and zinc and lead fell 4%. Oil fell US66c to US$69.87/bbl.
Somewhat lost in the wash of all of the above was last night's release of the US April consumer price index, which fell 0.1%. It was the first fall in the index since March 2009. Annualised inflation is now running at 2.2% which again puts no pressure on the Fed to raise.
Nevertheless, FOMC members are at odds over maintaining the near-zero cash rate. The minutes of the last Fed monetary policy meeting were released last night, and it featured an upgrade of the central bank's US GDP forecast in 2010 from a range of 2.8-3.5% to a range of 3.2-3.7%. Some members are calling for a rate rise and/or the commencement of selling down the mortgage securities the bank has bought since 2008. There is further talk of allowing Treasuries bought be the Fed in its quantitative easing phase to mature rather than rolling them over. In other words, some members are eager to start reducing the bank's now enormous balance sheet, just as the ECB is building up its own.
No resolution was reached and members agreed to disagree, so no changes at this stage. One presumes Bernanke is thinking right now is not a good time to bring more upward pressure to bear on the US dollar at a time when the euro is going down the gurgler.
The turnaround in the US was clearly enough to give a hammered local market at least a little bit of heart last night, given the SPI Overnight closed up 7 points.
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