Daily Market Reports | Jul 02 2012
By Greg Peel
I commented on Friday that there was more market downside potential likely to stem from the EU summit than upside. Were the summit to end in deadlock, it would have been “risk off” all round. Were the summit to end with general agreement to think about pursuing certain ideas further, in the fullness of time, as has most often been the case with these gatherings, then status quo would have been a more likely result than any strong upside. The world entered Friday's session with a degree of weary scepticism.
Which is why the world was ultimately so shocked. The news began to flow out of the summit late in the local session on Friday afternoon and for the first time in two and a half years it seemed European leaders were finally ready to take some decisive action. Why this didn't happen two and a half years ago? Well that's politics, but while not offering an end to eurozone debt problems, the new measures announced finally begin to address the heart of the problem.
The heart of the problem is European banks. They need to be recapitalised if they are to survive, loaded up as they are with the near-default sovereign bonds they were pushed into buying way back when by the ECB, along with dud mortgages and other loan issues. The more bond yields blew out, the more trouble the banks were in. The ECB has thrown money at the banks through LTROs but this has not been on-lent into the eurozone economy, and has not solved the problem. The ECB, at different times has directly purchased stricken bonds, but such influence has proven merely temporary. The EFSF and ESM have been set up but not fully deployed. The last hand-out amounted to a pledge of E100bn to the Spanish government so that the government could support its banks. That pledge amounted to further sovereign debt for Spain, creating more of a vicious bond valuation cycle. The world was somewhat incredulous when this was the best Europe could come up with.
Last week's summit was the nineteenth since the crisis began, many of which were meant, at the time, to be the summit that would resolve the issue once and for all. When Greece went down in 2010 many warned of contagion – first to the likes of Ireland and Portugal and then on to the big fish of Spain and Italy. Others scoffed at the time, but here we are with Spain on the brink and Italy looking vulnerable. The EFSF and ESM were set up to provide a firewall against such contagion. The time had come. European leaders knew that a failure to agree on direct action at this summit would possibly mean complete collapse. Most of the resistance to date has come from Germany, which is not unreasonable given Germany is the eurozone's default banker. The outcome of this summit very much depended on what concessions Angela Merkel would provide.
Before the summit began, Merkel agreed to an E120bn stimulus package to promote zone-wide economic growth and job creation. This was a concession from the leader who has until now insisted on budget cuts and strict austerity. But spending cuts mean economic contraction which means lower tax income which means even more difficulty servicing debt – another vicious cycle. Elections across the zone have seen the rise of the pro-growth push, led by France, and Merkel has been forced to bow. She was not, however, before Friday, prepared to entertain the idea of a single banking union across the eurozone, or indeed any euro-bond. Both would mean Germany losing control of its own funds. Instead she has insisted on a closer fiscal union before any further monetary consolidation could be considered – a process that would have taken years.
Europe doesn't have years, so on Friday Merkel conceded further and it was announced that a bank supervisor would be put in place and the supervisor's task would be to use EFSF/ESM funds to directly bail out troubled banks. The bail-outs would not pass through respective sovereigns and thus not increase sovereign debt obligations. It was also announced that the E100bn loan recently made available to Spain would not be ranked as senior to existing debt, placating bondholders who saw their valuations diminish further on being pushed down the queue. And it was suggested EFSF/ESM funds could be used to buy sovereign bonds directly in the secondary market, thus countering fatal yield blow-outs.
On that news, the yield on the Spanish ten-year bond plunged about 50 basis points, from 7% to under 6.5%. The Italian equivalent dropped to under 6%. These two numbers have been the focus of global attention these past months. The higher they have gone, the closer a catastrophic collapse of the eurozone has appeared. It is movements in these numbers which have promoted “risk off”. So when they go the other way, it's “risk on”.
And boy was it risk on across the globe on Friday.
The euro surged by 2.4%, sending the US dollar index plummeting 1.4% to 81.59. Commodity prices soared. West Texas crude jumped 9% or US$7.18 to US$84.87/bbl. Brent rose 7% or US$6.44 to US$97.80/bbl. Previously weary base metals prices leapt 2-6%, with copper up 4%.
Gold surged 3% or US$47.10 to US$1599.10/oz. In this move gold is not wearing a “safe haven” hat, but a monetary inflation (and reverse of the USD) hat. Silver jumped over 4%. The Aussie dollar is up over two cents to US$1.0255.
US ten-year bond prices fell 5%, sending the yield up 8bps to 1.66%. The VIX volatility index fell 13% to 17.
Stock markets were not going to be left behind. The Australian market finished with a flourish on Friday afternoon. The German stock market rose over 4% and the French almost 5%, and the Spanish and Italian markets around 6%. The Dow jumped 277 points or 2.2%, the S&P gained 2.5% to 1362 and the Nasdaq soared 3.0%.
The SPI Overnight was up 38 points or 0.9%, reflecting the running start the ASX 200 received on Friday afternoon.
It was a remarkable session. So what now?
Europe's debt problems have not gone away and have not been resolved. What we saw on Friday was a shift in the attitude of European leaders, perhaps out of desperation but at least out of necessity. Since 2010 we have heard nothing but “we'll do whatever it takes” and seen nothing but pathetic dithering and disagreement. This EU summit has brought us closer to “whatever it takes”. The world cannot yet relax but it can rest a little easier.
It's just as well, as it was announced on Sunday that China's official manufacturing PMI has slowed to its weakest rate of growth in seven months, falling to 50.2 in June from 50.4 in May. It's not good news, but it's not so bad given the figure still implies expansion, albeit only just, and given economists had been expecting a result under 50. HSBC's equivalent calculation has been under 50 for a few months nevertheless, and the HSBC confirmation result will be published today.
The Chinese PMI only serves to heighten expectations Beijing will step up its policy easing, perhaps cutting interest rates again in the near future. And on the subject of rate cutting, this week brings decisions by the ECB, the Bank of England and the RBA.
The ECB is widely tipped to cut its cash rate, perhaps by 50bps to 0.5%. In light of summit developments, we'll have to wait and see whether Draghi still considers such a cut necessary. The BoE won't cut but may talk about further QE, while in Australia it is likely the RBA will pause after 75bps of cuts in the last two months, and more positive signals from Europe.
The RBA meeting is tomorrow, preceded by the release of the TD Securities inflation gauge today and the RP Data-Rismark house price index. Australia will follow on from China with its manufacturing PMI and tonight sees PMIs from the eurozone, UK and US. China will provide its services PMI tomorrow and the world will follow suit on Wednesday.
Tomorrow in Australia also brings building approvals, on Wednesday it's retail sales, on Thursday the trade balance, and Friday's construction PMI wraps up a busy week. This week also introduces – just in case you've been living under a rock – the carbon and mining taxes.
In the US we'll see construction spending tonight along with the manufacturing PMI, and on Tuesday it's factory orders and vehicle sales. The NYSE will close at 1pm on Tuesday (3am Sydney time) ahead of the Independence Day holiday on Wednesday, for which all US markets will be closed. The holiday pushes the release of the ADP private sector unemployment numbers to Thursday, along with chain store sales, and on Friday it's non-farm payroll day.
The July 4 holiday typically ushers in the US summer vacation season. As to whether traders will be rushing out the door with signs of hope in Europe and jobs numbers to consider this week is another matter.
Today is a feel-good day. Whether that mood can be sustained is also another matter, and no doubt there will be more European roadblocks and stumbling ahead. But we'll take it for now. Happy New Year.
For further global economic release dates and local company events please refer to the FNArena Calendar.
