A short time from now, the results of the final Irish vote on the new and severe austerity budget of Finance Minister Brian Lenihan will be made public. In all likelihood, the budget will pass, but a failure has the potential to send the entire market upside down so soon after the jump in CDS and bond rates last month. Reflecting this sentiment, the Euro has settled near the unchanged level after moving up and down for much of the day, while the USD is lower by as much as 1% after making similar movements during the day. Gold has been volatile, and after testing $1429 and breaking a new record during the day, it is down by around $5 on the day as this is being written. Stocks, however, are up across the board, with weakness limited to Japan and Asia. Europe and the U.S. are up strongly.
Today the Fed is reported to have continued the heavy bond purchases of yesterday, and today's action recorded an all-time high acceptance rate of 41.5% in two separate bond purchases worth $6.8 billion, and $16.4 billion. Apparently in response to the weak Friday NFP number, Ben Bernanke has committed his institution to a very aggressive course where the self-imposed $600 billion limit could be exceeded easily. Certainly, data releases in 2011 may show some improvement in the U.S. economy, but it is unlikely to be strong, and with the European issues in the minds of traders and consumers, we find it difficult to believe that a significant change in the growth path of the U.S. can be achieved. Most statistics earlier this year implied that the U.S. would be in a recession by now, and it is not too much to assume that the revival in activity is at least in part due to the expectations of aggressive Fed intervention in the economy and the market. As such, we suspect that as the end of the announced bond purchase period approaches, investors and consumers may begin to retrench once again, necessitating a further dose of quantitative easing by the Fed, which seems only too willing to supply as much of the favored medicine as possible, with almost no concern about the side effects. The USD, in particular, is the sufferer.
In Europe, as we mentioned, it is more of the same today, with limited directionality in the market action of the most important segments, but we note the critism of Dominique Strauss-Kahn, the IMF director who commented today that "the euro zone has to provide a comprehensive solution to this problem," after meeting Greek prime minister George Papandreou in Athens, adding that "the piecemeal approach is not a good one." His agreement with the Greeks is not a surprise, since they are on the receiving end of aid, while the IMF director's main interest is ensuring that the global financial system is spared the shock of a Euro breakup at all costs. The Germans, who appear to be the main objectors to the proposals of improved EFSF coverage, and joint bond issuance, are the ones to pay, and their position is equally understandable. They have been fleeced enough in consequence of their commitment to the European project, and that they don't appreciate any more of the sour dish is not to be blamed on the choosiness or gluttony. And yet, here lies the crux of the matter, since when all sides have meaningful, solid arguments and positions that appear difficult, if not impossible to reconcile, a deadlock has been reached, and a solution will be much more difficult to find. That is what seems to have happened in the Eurozone. To be sure, the bailout party is not over yet, since the politicians will yield once they are cornered again and forced to make a yes-or-no decision. But this cannot go on forever.
In yet other Eurozone and ECB news, we have the quaint announcement today that another round of stress tests will be conducted in February, since it has become apparent that the market does not take the July's mock-examination seriously. The problem that the ECB faces in this issue is that each time they undertake to conduct successively stricter tests, and fail to apply criteria as severe as the market would like to see, they risk creating a self-sustaining cycle whereby investors unnerved by the dishonesty of the ECB sell-off on risk, and undermine the financial status of the banks which the tests had tried to assess. And when the deterioration in the situation is so sharp that it can't be ignored anymore, the central bank moves to repeat its actions, with unsavory results. Let's hope that this time the ECB will not be as conservative in its risk assessment as it is with its monetary policy.
3-month Euribor is one bp higher today at 1.029% vs. yesterday's 1.028%. The PBOC kept the USDCNY rate near unchanged.
Today is a day of suspense and rest for the markets, and it is possible that trading will go into a weaker tone as the end of the year approaches. One must not underestimate the possibility of a Euro rally, however, since many traders will prefer to close positions heading into this period in order to cash out on profits, reassess strategies, and for bookkeeping purposes. All that could lead to a Euro rally, but we don't think that the 2011 outlook for the currency is bright given the large number of open questions that await their answers. The Fed may be determined to supply as much cash to the market as it needs in order to fulfill the narrowminded goals that it has defined for itself, but Eurozone problems, and the future of China remain the key issues nonetheless, and may easily undo or make irrelevant whatever choices the Bernanke team may take.
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