Daily Market Reports | Sep 07 2011
By Greg Peel
The Dow closed down 100 points or 0.9% while the S&P fell 0.7% to 1165 and the Nasdaq lost 0.3%.
Tomorrow the eurozone may be no more. At least that would potentially be the fallout were the German constitutional court to deliver an adverse ruling prior to the opening bell on Wall Street tonight. The court is to decide whether the initial bail-out of Greece in 2010 breached the German people's property rights, whether the government acted illegally in contributing to subsequent Portuguese and Irish bail-outs without first obtaining parliamentary approval and, on an EU scale, whether ECB purchases of eurozone sovereign debt are illegal under the Maarstricht Treaty.
Legal experts do not, however, believe an adverse ruling will be delivered. Rather they expect the court to insist all future loan packages to eurozone members must first be approved by the German parliament. Such a ruling might save the eurozone, but it would also restrict the German government's capacity to act swiftly in a financial crisis. European response times have already been painfully protracted. The requirement for parliamentary approval would only slow the process further and encourage more market volatility in the meantime.
It is also expected that tonight German chancellor Angela Merkel will address parliament. As a compromise offer, her party has drafted a proposal to grant the German parliament veto rights over the European Financial Stability Fund.
Why does Germany want to save the eurozone anyway? Recent election results suggest the German people are dead against using taxpayer funds to prop up profligate Club Med members and were there are general election tomorrow, and not in 2013, Merkel would most likely lose power to those pushing an anti-euro barrow.
There are two reasons: (1) allowing eurozone members such as Greece to default and withdraw would resonate back into German banks holding Greek and other eurozone sovereign debt, impacting on taxpayer loans and deposits anyway; and (2) Germany has been the greatest beneficiary of the common currency, given the weakness of peripheral economies has offset the strength of German and other northern European economies, keeping a cap on what would otherwise be the German mark, and thus rendering Germany's significant export industry competitive on a global scale. Germany's economy relies heavily on its manufacturing industry, and we all know what happens to manufacturing industries when one's currency becomes overly strong.
The Swiss certainly appreciate this problem, which is why last night the Swiss National Bank shocked the world by announcing the franc would no longer float freely, but would be capped against the euro at an EUD-CHF rate of 1.20. The Swiss franc was trading at EUD 1.12 at the time of announcement and hence rallied (ie the Swiss franc fell) nearly 10% in a blip – an extraordinary move for any currency.
All year the Swissy has been the paper currency of choice, playing global safe haven alongside gold. Like Australia, Switzerland's economy has been suffering as a result.
This was the state of play in early trading in Europe last night, which saw further substantial falls on European stock markets. The German index fell another 4% having fallen 5% the night before, and European bank stocks were all again down double digit percentages. Having had a day off, Wall Street opened in the middle of the ongoing mayhem. The Dow immediately fell over 300 points.
Did anyone say Lehman? The CEO of Deutsche Bank certainly did on Monday to much criticism. The similarities are obvious – in 2007, US and other investment banks maintained unrealistic valuations of toxic CDOs on their books when a mark-to-market would effectively render them worth zero, and once mark-to-markets were enforced the ensuing solvency crisis threatened to bring down all US institutions. In the end, only Lehman was allowed to fall. In 2011, European banks are valuing sovereign debt positions for Greece et al on their books at unrealistic levels on the basis of default being prevented by ECB and bail-out fund intervention. Were these bonds to be marked to the levels priced by bond markets, European banks would find themselves insolvent. Of course we can't really call the situation in reality “another Lehman”. It's just the same Lehman, which was passed on to public from private hands and has never gone away.
Yet it is also true that the worst of the sovereign debt positions held by European banks represents only about 6% of bank capital – enough to spark capital adequacy and liquidity issues but not enough to render a bank insolvent as long as the credit market does not freeze as it did in 2007-08. Last month new IMF chief Christine Lagarde told European banks they needed to urgently recapitalise with private funds ahead of public funds where necessary. Yet most European banks have lost around half their market capitalisation value in 2011, so raising new capital at these levels would be basically untenable. Last night the IMF backed away from Lagarde's statement and suggested the number of European banks requiring forced recapitalisation are actually very few.
It was a turning point.
Around the same time, the Greek finance minister stepped up to say that the Greek government intended to speed up the structural reforms and austerity measures need to satisfy bail-out requirements. Can we believe him? Yesterday it seemed as if Greece was deliberately failing to comply, eyeing default and eurozone exit as the lesser of the evils. But the minister insisted that implementation was indeed progressing, it was just being held up in a backlog of reforms.
And while all of this was going on, general strikes were underway in Italy to protest Italy's new austerity package, as insisted upon by the ECB, as it moves to debate in the Italian senate.
As European stock markets headed towards their closing bells and the morning session on Wall Street unfolded, a rally ensued. The German and French markets ultimately closed down only 1%, while London closed up 1%. Wall Street wobbled its way up but by its closing bell the Dow had recovered 200 of those initial 300 points.
Aiding buying interest on Wall Street was the release of the US services sector PMI, which rose to 53.3 in August from 52.7 in July when economists had expected a fall to 51.0. Could all this talk of double-dip again be overly pessimistic? Jobs aside, US economic data have not been that bad of late. Throw in what transpired in Europe overnight, which by day's end seemed almost more encouraging than discouraging, and clearly there were enough bargain hunters seeing value in US stocks.
The German court could throw a spanner in these works tonight, but that is not what is expected.
If the Swissy is no longer a safe haven option, where does the money go? Well the obvious choice is gold, and that's exactly where the money went initially. Spot gold traded up to US$1920/oz and talk was of US$2100-2200 now being a given in the wake of the Swiss move, but by the same token the near 10% collapse in the Swissy sent the US dollar index up 1% to 75.93, providing US dollar gold with quite a headwind.
In the end, gold fell US$26.70 to US$1873.60/oz but this was most likely reflective of some profit-taking, with few expecting the gold trend to alter at this stage. But gold is a very crowded market now, many note, rendering it less attractive as safety investment.
US bonds perhaps? Well if you buy US bonds now as a safe haven against both European bonds and a US recession you'd probably find buying support from the Fed later in the month, with QE3 expected to take the form of a sell short-buy long end “twist”. But under 2%, the US ten-year yield is as low as it has ever been, including in the GFC, so there's not a lot of upside. By the close that yield was little changed at 1.98%.
Perhaps the true safe haven answer lies in something real, something “hard”, something that actually has a purpose beyond funny money currencies, unpayable debt and shiny stuff. Perhaps that's why Brent crude was up US$2.97 to US$112.89/bbl last night, despite having fallen the night before, and despite the big move up in the dollar index. West Texas crude closed little moved at US$86.51/bbl, but then that effectively represents two days of trade, and WTI is irrelevant anyway.
One might argue the same could be true for base metals, but base metals do not hold the same “monetary inflation hedge” aura as does oil. So last night base metals were little moved.
So how does all of this affect the Aussie? The Aussie is down half a cent in 24 hours to US$1.0493, but that's as much about a slightly weaker than expected June quarter net exports result released in Australia yesterday ahead of today's GDP result. So really the Aussie is maturing, one might suggest, into not just a risk trader's plaything but into an actual safe haven substitute. Unless, of course, the developed world falls apart again and takes China with it.
And what of our poor, battered stock market? Weighing up the developments of Friday and Monday's trade against the moves in Europe and last night's move in the US, we appear to have been oversold. On that basis, the SPI overnight is up 60 points or 1.5% to recover some ground.
From here on anything can happen, and probably will.
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