Still reaching for the handbrake on EU enthusiasm

More John J Hardy, 5 days ago05 December 2011 Non-Independent Investment Research As the European economy crumbles, with further weakness a guarantee in the wake of this week’s EU austerity-inducing deal, we wonder how long markets will continue to throw caution to the wind.

Friday’s action finally saw risk appetite taking a bit of a breather after an over-the-top attempt to rally even further on top of the week’s already heady gains. Putting a slight damper on the action Friday was a US employment report with merely in-line payroll numbers and not particularly encouraging internals, notwithstanding the news that the most widely followed US unemployment rate benchmark had fallen 0.4% to reach 8.6% in the month of November. 

Nonetheless the world woke up today in a more hopeful mood for the week, as it appears the market firmly believes the EU is about to deliver “something big”. Certainly if we are to judge from the likes of EU sovereign debt spreads, the turnaround in sentiment has been remarkable, if not to say stunning. We’ve gone from “on the brink” to “all systems go” in the mere space of days. Spain’s 10-year spread to Germany for example, has absolutely screamed tighter to the tune of 150 basis points over the last couple of weeks, falling another 30 bps today. Interestingly the original “PIG” countries have not seen the same development. And the Euro basis swaps, while they have improved very sharply since the coordinated intervention last week, they are still below the lowest levels they suffered in September at around -125 bps this morning.

But is the enthusiastic embrace of this week’s plan a sustainable move and can the situation be so simple? Our chief economist Steen Jakobsen certainly asks the important questions for this week and asks whether the eventual EU deal this week is simply the latest exercise in buying time while not confronting the bigger issue of insolvency. At the same time, he points out how the EU/ECB has long been riding roughshod over critically important standards of behaviour, and that this deal may represent a new low point for that behaviour. 

As Steen suggests, this issue of “standards of behaviour” applies far beyond the borders of Europe as well, of course, as we all have to wonder what will ever stop the hubris of governments and central banks around the world, most critically the Bernanke Fed.

Looking ahead
Today we saw another round of slightly disappointing European data in the form of the Services PMI’s for November, which were revised slightly lower. The UK data, meanwhile, actually perked up. Up later, we have the critical US ISM non-manufacturing data, an indicator on the critical US services sector, which suddenly stabilized around 53 in recent months. 

Later today we have likely announcements further outlining the shape of the EU deal to come as Merkel and Sarkozy are meeting today and have promised further details. Later this week, of course, the two focal points are Thursday’s ECB and Friday’s final day of the EU summit.

As I have discussed frequently in the past in this column, a couple of important questions to ask while the markets are going nuts in celebration in recent days are the following:  first – what will a much easier stance from the ECB on rates and likely QE mean for the Euro once the “relief trade” dies down? (Or will the market be so impressed by the extreme austerity that it celebrates fiscal probity, even though that risks setting of a vicious debt deflation/depression cycle?) Two, and related to our parenthetical question – massive austerity is still the name of the game for Europe, guaranteeing a recession in the coming couple of quarters at least – so how sustainable will any solution be without massive debt destruction, and without a full QE agenda for ECB, have the days to the next EU debt crisis merely been re-numbered?

One development overnight worth noting is the Chinese equity markets further descent toward lows for the year. While the rest of the world toasted the PBOC’s move to cut the RRR ahead of the  global central bank intervention on USD swaps, the local market has now fallen back to within a stone’s throw of two-and-a-half year lows. China is a critical engine in the world’s economy and certainly bears close watching.

On that note, the RBA is out meeting tonight and expected to cut 25 bps to bring the rate to 4.25%. Guidance will be critical as always. The last several trading days have seen rate cut expectations reeled in drastically as a function of the expected stability from an EU deal. But with China apparently on the ropes here, we wonder whether the market has its eye on the wrong ball. Recall that the 1.0415 (200 day moving average) area is critical for AUDUSD.

Economic Data Highlights 
Australia Nov. AiG Performance of Services Index out at 47.7 vs. 48.8 in Oct. UK Nov. Lloyds Employment Confidence fell to -75 vs. -72 in Oct. China Nov. HSBC Services PMI out at 52.5 vs. 54.1 in Oct. Germany Nov. Final Services PMI revised down to 50.3 from 51.4   EuroZone Nov. Final Services PMI revised down to 47.5 from 47.8 UK Nov. Services PMI out at 52.1 vs. 50.5 expected and 51.3 in Oct.
Upcoming Economic Calendar Highlights (all times GMT)
US Nov. ISM Non-manufacturing (1500) US Oct. Factory Orders (1500) Us Fed’s Evans to speak (1710) Sweden Riksbank’s Wickman-Parak to speak (2300) UK Nov. BRC Sales Like-for-like (0001) Australia Q3 Current Account Balance (0030) Australia RBA Cash Target (0330) Tags: forex, EURUSD, AUDUSD, macro 284 Views 1 Like! 0 Comments 1 Follow In order to like something, you need to be a member.
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