Daily Market Reports | Nov 22 2011
By Greg Peel
The Dow fell 255 points or 2.2% while the S&P lost 1.9% to 1192 and the Nasdaq dropped 2.0%.
The weekend's landslide Spanish election win by the former opposition party has ushered in a new government determined to implement reforms needed to ease the Spanish debt problems. This is good news for the world looking in on top of the appointment of technocrat governments in Greece and Italy with the same agenda. It does not, however, solve the eurozone's major problem.
That problem remains one of how to leverage up the EFSF when the rest of the world is reluctant to provide the funding. The problem could be solved, many a commentator suggests, by expanding the balance sheet of the ECB via printed money but that unfortunately requires constitutional change. Germany is also opposed because Germany would become the ultimate lender at a time when the German electorate is already angry at its taxes being used for bail-outs. Were Merkel to agree to go down the ECB route, her government would most likely be voted out at the next opportunity.
France is very pro the ECB solution because it is France's banks carrying the bulk of the debt burden. There is also an election coming up soon and Sarkozy does not want to lose power based on a collapse of the French banking system.
As the wrangling continues yet again, bond markets continue to deliver their own verdicts. Italy's benchmark yield is hanging just under danger territory at 6.8% while the Spanish election made no difference to the Spanish yield which remains at 6.6%. The ECB has been buying both bonds so one wonders what might otherwise be. In the meantime, yields on AAA-rated sovereigns such as Finland and the Netherlands are also on the climb as is, most ominously, that of AAA-rated France. The spread of the French yield over the German yield has traded as high as 200 basis points to mark a eurozone era record. Ratings agency Standard & Poor's has warned that were such a spread to persist France's rating would likely need to be downgraded.
Such downgrades can set off a slippery slope as AAA-only mandated investors sell their bonds and push yields ever higher. The only sovereign this rule doesn't seem to work for is the US, given August's rating downgrade has made no difference to the demand for US bonds. And why would it? Where else do investors go?
Indeed, last night the yield on the US ten-year fell 5bps to 1.96%. In isolation, this seems like a bizarre response to what has been happening on Capitol Hill. Wall Street had become jittery last week but straws were clutched in the hope the US budget deficit Super Committee, comprised of a balance of Democrat and Republican senators and reps, would reach an agreement on the weekend. It didn't, and it still hasn't ahead of tomorrow night's deadline.
The Super Committee was formed back in August when the inability of the Obama administration to pass its budget policy through the Republican majority House sparked both a temporary lifting of the US debt ceiling and the aforementioned S&P downgrade. In essence, the Super Committee represents a postponement from that time such that US$1.2bn of deficit cuts must be agreed upon in their make-up. If not, automatic budget cuts of the same amount will be triggered in 2013 which will mean mandatory cuts to defence, education, environmental spending and so forth. As we approach the deadline the Committee itself is suggesting they may yet be able to reach a resolution. Wall Street however, is frustrated, angry and not convinced. One of the reasons S&P removed America's AAA-rating was exactly this political stasis. Another failure to disagree will likely mean S&P downgrades again.
And that's what had Wall Street tumbling last night, with additional impetus from Europe. Investors everywhere are simply sick of the bruises on their foreheads from banging them against brick walls. It was an across the board “risk off” trade with little being spared except, as noted, US bonds.
With European stock markets down around 3%, Wall Street sold off sharply from the open to be down 342 Dow points around lunch time. At that point it appeared the Super Committee was destined for failure but a late announcement from the Committee that it had a new idea on the table at the eleventh hour encouraged a rebound of sorts, such that the close was not quite as bad. The problem is, however, that the Committee does not have a lot of incentive.
The automatic budget cuts that would be triggered due to failure will not apply until 2013. Prior to that, some new budget bill could simply be passed through Congress. Next year is an election year and hence neither side wants to be seen to be backing down to the other while at the same time trying to lay the blame on the other. It is simply bare naked politics and the cretins on the Hill don't seem to be at all concerned how much they are seriously pissing the whole world off, as well as angering and embarrassing Americans.
“I've spoken in recent days to some of the best fund managers in Australia,” noted Goldman Sachs Australia's head of institutional sales Richard Coppelson in his afternoon note yesterday, “some who've been investing for over thirty years and they all say they haven't seen anything like this before. The markets just have no fabric and investors are so confused about what they should be doing that many have decided the best option is to do nothing. I've had a few fundies telling me they are taking three to four weeks off just to get away from the inertia that markets are stuck in at the moment”.
In other words, no one wants to play “risk” in this market. And last night every “risk” asset took another hit.
The US dollar index was slightly up at 78.24 despite the threat of a downgrade and the ever growing belief QE3 will be necessary because in exchange rate terms it is simply a “lesser of the evils” trade between the dollar and the euro. But the Aussie “risk indicator” fell one and a half cents to US$0.9869. Gold was sold down US$39.90 to US$1684.00/oz on both a cash raising exercise and the threat of a deflationary global recession.
Base metals ignored news of increased Chinese demand in October as all bar nickel fell 1-3%. Brent fell US$1.66 to US$1.0607/bbl while West Texas rolled into the January front-month to close at US$97.29/bbl.
The SPI Overnight fell 64 points or 1.5%.
Bring on Christmas.
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