Trend drivers of the prior and coming week, and how to play them:
PRIOR WEEK MARCH 7-11
EU DEBT CRISIS FEARS RE-EMERGE
This was by far the biggest market mover of the past week, as a steady stream of bad news about the PIIGS sovereign debt and banking crisis battered markets this week. Highlights included:
This is the really big concern that leads us to believe the EURUSD, EURJPY, EURCHF and EURGBP are likely to head lower over the coming weeks at least. Why? The short answer is that EU leaders will not be politically able to make the needed concessions to reach an agreement on a much larger bailout package until threatened with financial Armageddon, as we discuss in detail here. For a more detailed description of the politics behind the paralysis, see here.
We are currently in stage 5 of the 7 Stages of the EU Panic Cycle, the one right before crisis hits. This stage is characterized by exactly the conditions we’re seeing now:
- One or more nations rapidly approaching a default unless there is a bailout deal – such is the case now for Greece, Ireland, and Portugal.
- EU summits that fail to produce agreements that offer a believable package of cash, concessions, and details about who is committed to provide them. Instead market hopes are raised about imminent agreements, then dashed when:
- These turn out to be mere agreements to agree at some later time: For example, this past Friday market hope rose when the EU President sent a premature tweet that there was an agreement, but then quickly deleted it, because it was only an agreement in principle (i.e. no concrete commitments or details).
- New disagreements emerge as opposing sides jockey for position and play to their voters. For example seekingalpha.com reported Friday: “Speaking in Brussels ahead of an EU summit, Enda Kenny rejects Angela Merkel’s offer of a lower interest rate on the bailout loans in return for Ireland raising its corporate taxes. ‘(I have) a very strong mandate from the Irish people … I would not support any adoption of a common corporation tax rate.’ “
Markets crashed last spring after a series of similar failures to produce any concrete solution convinced traders that the risk of EU and EUR collapse was, if not likely, certainly a very real possibility.
Despite all this, the EURUSD still managed to salvage the week with minimal damage due to a surge on Friday that recaptured about half of the week’s losses. Click to enlarge:
EURUSD DAILY CHART COURTESY OF ANYOPTION.COM 06MAR 13 0020
The rally wasn’t due to any improvement in the EU. Rather it came from a fizzled attempt at a ‘day of rage’ in Saudi Arabia that eased concerns about oil production, sent oil prices lower, and risk assets like the EURUSD and other primary EUR currency pairs higher.
MENA UNREST & OIL PRICES
This remained an equally potent market mover. For example:
- Tuesday’s rallies were due in no small part to OPEC talk about making up for lost Libyan production.
- Thursday’s selloff was largely from news of violent confrontations in Saudi Arabia
- Friday’s rally in risk assets was mostly fueled by the failure of a planned ‘day of rage’ to stir much open support, thus easing concerns about further oil supply interruptions.
There was continuing fighting in Libya, and ongoing unrest in Yemen and Egypt, but these failed to noticeably move markets
CHINA TRADE DEFICIT
A surprisingly bad Chinese trade deficit report shook Asian and European risk asset markets, and combined with the above noted violent suppression of Saudi protests to spark the steepest selloff in 7 months worldwide.
COMING WEEK MARCH 14-18
EU SOVEREIGN DEBT & BANKING CRISIS
In addition to changes in PIIGS bonds yields and debt auctions, specific events include:
Tuesday March 15 Ecofin Meetings
As the final preparatory meeting for the supposedly climactic, decisive March 25th meeting of EU leaders, the finance ministers meet to work out further details, at least that’s the idea.
As noted above, the odds favor more disappointment and downside for the euro if not broader markets. However, don’t be surprised if we get short term rallies based on more news of agreements that fail to calm markets because, also noted above, neither funding nor debtor nation leaders can yet back down from their positions until a crisis provides them the needed excuse to make concessions their voters oppose.
Friday March 18 EU Bank Stress Test Details
EU authorities will publish details regarding the macro economic scenarios and the sample of banks that will undergo the tests. These will help markets determine whether the tests are strong enough to accurately describe the bad debts and recapitalization needs of some of Europe’s weakest lenders, especially the Spanish regional Caja banks.
While US policy makers were able to quickly calm markets about US bank stability via a combination of quickly deployed guarantees, and selective, partial transparency about the extent of US bank troubles, EU leaders did neither, and thus uncertainty about its banking system is more of a problem for the euro than the USD.
More details will follow in April when the stress test methodology is disclosed and then in June when we finally get the results. As noted above, the lack of standards for defining Tier 1 capital has already cast doubt on the value of the tests, so the EU has a chance to rebuild its credibility. Market reaction isn’t easy to gauge.
Last summer the tests were not believed to be serious, and indeed, as we noted above, Ireland proved they weren’t. Nonetheless, after pulling back on doubts about these tests, markets rallied once they saw the high ‘pass’ rate.
MENA UNREST INSOFAR AS IT AFFECTS OIL PRICES
Obviously these events are both very influential but very unpredictable in the short term. Over the coming weeks there is a good chance oil prices could return to the mid $80s if the political picture clarifies, because whoever establishes control will want to sell oil. The current consensus is that opposition in Saudi Arabia is not likely to be as potent as in Egypt and Libya. Although Saudi Arabia has similar demographic and employment pressures, the King is better able to buy off his opponents. The country has no history of strongly organized social movements, but of course, the same is true for much of the MENA region.
JAPAN EARTHQUAKE, NUCLEAR REACTOR SHUT DOWN RAMIFICATIONS
The affects of the earthquake that hit Friday, and the nuclear reactor shutdown are not known at this time, but are potentially significant. Thus far, we do know that about 12.5 GW of nuclear power generation capacity, or 26% of Japan’s total available capacity, and 935K bpd of refining capacity, 20% of the total, are gone for now. Due to MENA closures in refiners and restricted imports, regional crude oil prices will be pressured in the coming week. However the impact on crude oil prices will be temporary, and we expect a reversal of these conditions as soon as refineries and power generation resume operations.
FED OUTLOOK IMPROVING?
Though the solid results produced no noticeable market reaction, they may yet have influence via the Fed’s statement accompanying its monthly Fed Funds Rate announcement. While no change in rates is expected, the comments that follow may reflect changes in Fed thinking on rates. With expectations for rate increases so low, the USD could get a lift on even a slightly more hawkish tone.
Retail sales rose 1.0 % in February from upwardly revised growth of 0.7% for January. This was the strongest growth rate in four months, and the report details show an underlying increase in demand not just from higher gasoline prices but also from increased spending for a wide variety of discretionary items like clothing and electronics.
This increase is important because it shows that the improving jobs picture is also lifting spending. Jobs and spending are the prime metrics the Fed considers for determining the pace and extent of rate increases that will eventually come. Watch for any change in the “extended period” wording for low rates or any hints of the Fed ending its bond buying program.
When these happen expect the USD to rise, and stocks to fall. Since the GFC (Great Financial Crisis) began in 2008, equities have been supported by a combination of low rates and available cash. These helped keep earnings higher (along with lots of cost cutting), and also encouraged yield seeking cash to flow into stocks.
SCHEDULED CALENDAR EVENTS
Highlights include
- 4 major central bank rate announcements (the Fed, BoJ, SNB, and Norway’s Norges Bank). No surprise rate increases, but the accompanying comments may signal surprise changes in policy biases that could move currency markets, especially if surprises come from the Fed. There’ also an RBA publication of monetary policy meeting minutes
- German ZEW economic sentiment
- US TIC long term asset purchases, PPI, core CPI, building permits
POTENTIAL WILDCARDS
We don’t know when these will crop up, but they are likely to do so at some point in the coming months, and can drive markets when they do.
In addition to the above, be on the lookout for further developments on
- China’s slowing growth (see here for more)
- Korean military tensions
- Additional trouble in US banking/real estate. Regarding the last point, there are unsubstantiated reports that a hacker will release damaging information on Bank of America (BAC) at some point this coming week.
DISCLOSURE & DISCLAIMER: AUTHOR IS SHORT THE EUR, LONG THE CAD, AUD AND USD, LONG SELECTED EQUITIES HELD AS LONG TERM INCOME/GROWTH INVESTMENTS, SHORT THE OVERALL STOCK MARKET FOR HIS PERSONAL PORTFOLIO. THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY AND NOT TO BE CONSTRUED AS SPECIFIC TRADING ADVICE. RESPONSIBILITY FOR TRADE DECISIONS IS SOLELY WITH THE READER
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