Yesterday we saw the markets come back with a vengeance as both stocks and risk assets traded higher. The obvious driver of these moves was the EU bailout, but as I mentioned yesterday, the bailouts are going to be negative for the Euro in the long-term. It didn’t take the markets long to realize this, as the Euro is lower and taking other markets with it.
Part of the problem we are seeing is that because the PIIGS countries are going to have to adopt austerity measures, this by nature is going to stunt growth while the debt situations get under control. However, when the US was facing economic crisis, the EU only had to lower interest rates and did not engage in quantitative easing to stabilize its economy. Now granted, they are facing problems today, but I think that stability is more important than growth at this point.
Nevertheless, the market still relies on some of the correlations that have held up over the past couple of years, and my guess is that is going to change. While the Euro is known as the “anti-dollar”, it tends to trade with risk assets. If we use the premise that the Euro is going to go lower based on the dilutive actions taken to administer the bailout, then it likely follows that we’re going to see some Dollar strength.
However, we still are seeing good growth stories around the globe. Sure a weaker Euro will decrease demand for imported goods to the EU, but it will also be much better for Euro exports as now their goods are cheaper around the globe.
So pay attention to how the other markets react to a declining Euro. Right now the markets seem to be playing by the old rules. It may be a while before the market catches on to the new paradigm. So for now trade what you see and not what you think it will be!
In the forex market:
Aussie (AUD): The Aussie is lower this morning as fears that a European economic contraction may weigh heavily on global recovery. However, the economic story is still intact and a global slowdown could halt inflation down under.
Loonie (CAD): The Loonie is holding up fairly well despite the risk aversion in the market as investors are betting on a rate hike next month. Swap rates are higher as homeowners are attempting to lock in fixed-rate mortgages in anticipation.
Kiwi (NZD): The Kiwi is lower as risk aversion in the market is causing demand to weaken. The target date for a rate hike is still mid-year, but that could be pushed out further if inflation subsists due to a lack of Euro or Chinese demand.
Euro (EUR): So stocks are lower in Europe and the US futures are set to open lower as well as there is concern that the bailout plan will not be big enough to halt the debt problems. My take is that this bailout should be sufficient, as spending gets slashed and budgets get reduced throughout the region. As long as this backstop is in place, the troubled nations will receive aid initially and will be able to go out into the markets down the road once more and more confidence is established. While the crisis everyone speaks about is directly related to excessive debt, the real crisis in the EU is one of investor confidence. If this process can be managed skillfully, the confidence will come back. In the meantime, I am expecting the Euro to decline. And watch the flows into gold as an asset class as gold not only acts as a hedge against inflation, but also as a store of wealth. Gold is higher to $1210.
Pound (GBP): The Pound is higher this morning as industrial production figures came in much better than expected. The Pound was initially lower on risk aversion and due to a report that the Lib Democrats in Parliament were in talks to form a coalition government with the Labour party even though the Conservatives won the majority though not by a large enough margin to dominate Parliament.
Dollar (USD): The Dollar started the morning higher on risk aversion but is giving back some ground as the stock market gets set to open. Stock futures are off their lows of the morning and I could see this as a “turn-around” day as the economic story is improving in the US.
Yen (JPY): The Yen is giving back gains as the market is seemingly moving away from risk aversion. Japanese stocks were lower overnight, as fears of a Chinese slowdown may affect earnings going forward.
In my opinion, the bailouts in Europe should be viewed as a good thing and not bad. A lower Euro will not only help manufacturing countries such as Germany and France as their exports will be cheaper, but it will also help the PIIGS countries as tourism will increase.
I live here in the NYC, and for the last couple of years you couldn’t walk down the street without bumping into a European here on a shopping excursion. Even with the price of the airfare, it was still cheaper for them to shop here than at home.
Conversely, the last time I was in Europe, I felt like a pauper and was astounded at some of the dinner bills I racked up. Now, my wife and I are planning our next trips. Things will get worse in the EU before they get better, but in the long run a lower Euro will benefit them greatly.
We all have to make sacrifices in the grand scheme of things, and once the Greeks (and those who acted irresponsibly) realize how they can benefit, the quicker they can return to normalcy.
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