Euro, risk assets fall as economic gloom spreads
06/Jun/2012 • Currency Updates•
We closed a very difficult week in financial markets for all asset classes. In addition to the usual litany of disastrous news out of the Eurozone, there were worrisome signs of economic slowdown worldwide. A key question that will be answered over the next few weeks is whether this weakening is a direct consequence of the European crisis and its impact on worldwide trade and business confidence. We hope this is not the case, as we still see no signs that a durable solution to the European trouble is in the offing. In any case, disappointing news out of the US, the UK, China and key emerging markets, together with signs that Spain will no longer be able to fund itself and its bank bailout in the markets, hammered stock markets, commodities, credit and most major currencies save for the two remaining safe havens: the US dollar and the yen. There is a faint silver lining among these depressing news, however: the sharp fall in oil prices over the past weeks will provide a moderate push to consumer spending in non-oil producing countries, as well as (we hope) ease the inflation hysteria that has so far prevented certain policy makers from taking proper measures. We remain convinced that forceful measures from the world central banks are coming; the question is whether they will be proactive and coordinated, or simply panicked responses to financial collapse.
The United Kingdom contributed its fair share to deepening worldwide gloom last week. The PMI business sentiment gauge for manufacturing fell more than 4 points to a depressing 45.9. It had not been this low since May 2009, in the aftermath of the Lehman crisis and associated worldwide economic collapse. The severe weakening of UK indicators, as well as the worsening crisis in Europe means that our out-of-consensus view of an additional easing this month or the next has gone from outlier to consensus in just a few weeks. The drop in commodity prices will also ease UK headline inflation, giving the MPC breathing room. We now think that there is a 2/3 chance of a move next week; should the MPC stay put, it will surely be forced into easing at the July meeting. Sterling had one of its worst weeks in many months, and managed to fall both against the Euro and the US dollar, as markets quickly priced in further MPC easing. We expect Sterling to revert shortly to its performance as a low-beta version of the Euro, once further easing from the ECB is priced in as well.
European authorities are quickly losing yet another battle against reality and basic arithmetic. It is becoming increasingly clear even to them that Spain cannot fund both its fiscal needs and the clean up of its real-estate laden banks without either outside help or exiting the Euro. As yields on Spanish 10-year bonds approach the psychological level of 7%, the inadequacy of current arrangements is obvious. Plans appear to be afoot to sidestep this limitation by targeting the bailout to Spanish banks rather than the sovereign as a whole; we think that this is just another of those distinctions without a difference so beloved by Frankfurt and Brussels. At any rate, the collapse of Spanish domestic demand continues apace. Retail sales fell in May an astounding 9.8% from the already depressed year-ago levels, and manufacturing sentiment is plumbing new depths. Not everyone suffers equally, though, as Germany is now able to fund itself at negative interest rates thanks to the crisis. We maintain a very bearish outlook on the European economy and the Euro, and expect very volatile trading over the next few weeks as news out of Spain continue to jolt markets.
The all-important US labor report deliver another blow to worldwide equities. Just 69,000 jobs were created in May, and the unemployment rate rose to 8.2%. It seems that we may have underestimated the impact of the European crisis on worldwide business sentiment, and the US is no exception. This report, while not exactly disastrous, does dovetail with a number of other weaker-than-expected data points in the US and elsewhere. We are still expecting the greenback to outperform other currencies, but we now think that growth in the US is more likely to be closer to 2% than 3%.