Market DirectionsVolatility without Direction
The dollar started the week at a four year peak against the euro and ended near the middle of the recent range. Perceived risk is the still the motivating factor for most traders, but the perception of the world economy and its potential for growth or fracture is stuck in post-financial crisis mindset. Case in point last Friday’s Non-Farm Payrolls in the United States. By any examination the numbers, particularly the private payrolls of only 41,000 on expectations of 180,000, breaking a four month string of improving results, were terrible but the numbers gave the dollar a solid boost against the euro. That is the risk trade.
Markets are far more concerned about the risk to portfolios and to capital than to the promise of expansion and growth. The dollar gains on heightened risk. It does not matter whether the risk is to the US recovery as in the NFP, to the banking system in Europe, as from the Hungarian Government statement on the likelihood of sovereign default, or the existence of a Chinese property bubble. Investors and traders buy the dollar and dollar assets in each case. One way to look at this trading reaction is that it is a residue of the financial crisis. Trading strategies will continue to be employed until they no longer make profits. If the market reaction to poor economic news or financial stress is still to buy the dollar than any trader who did not participate would have a good deal of explaining to do. But there is another justification for this prolonged bad news is good for the dollar trope. World financial and currency markets seem very reluctant to believe in the economic recovery. Perhaps the skepticism is even deeper than a simple wait and see attitude. Governments around the world have taken the same approach to the financial crisis and the recession. It is the Keynesian disbursement model with allowance for who has the money. Spend your own surplus, China, or run up massive debts borrowing from the private credit markets, and of course China, and distribute the funds to all manner of individuals, enterprises and bureaucracies hoping that enough of the money will find its way into the hands of consumers or businesses who will spend it in the economy. In other words the response to the crisis of 2008-2009 has been a massive and worldwide attempt by governments to support consumption. This approach may have succeeded in averting an even more serious recession or depression, though this is an assertion by its proponents not analysis because nothing else was tried. But the spending is a gamble. If the world economy does not pick up enough to raise government revenues, if consumers stay home because they are worried about their jobs and their own debt, then the massive new sovereign debt will fell budget after budget with austerity. If government disbursement is all or most of the recovery then its withdrawal, as in Southern Europe, could drop many recovered economies into a second recession. That is the fear behind market volatility. Can the enormous amount of debt amassed by governments really create economic growth? The basic fact of sovereign debt is that governments must have the cooperation of private capital to fund themselves. Capital markets are more concerned with the ability of the borrower to return capital than in how the funds are obtained. Bond owners will always be more interested in deficits and taxation than growth. Since governments must borrow but capital markets have many choices as to where to lend, it means that except for a favored few, governments will be forced to satisfy the restrictions of the lenders. Austerity budgeting will not be a device of a few disfavored EMU countries but may well spread across the globe. How does the world economy generate enough growth and revenue to please the capital markets in an era of budget reductions? With that background let us look at the statistics to be released in the coming week: Monday in Europe EMU industrial production figures for April are released. This is the first indication of second quarter trends; 0.5% is expected. The three months of the first quarter averaged 1.46%, but they were before the Greek debt issue grew into a crisis. In Germany the ZEW Survey for June is issued on Tuesday. The export driven German economy has performed better than its continental neighbors, helped by the falling euro. The EU debt problem has taken some of the positive aspect from this survey. May's reading for economic sentiment fell 7.2 points to 45.8 from April; 42.0 is predicted. In the United States the Treasury International Capital System from the Treasury Department is published. This report chronicles the net flow of funds into and out of US investment. When Washington’s very large deficits were news last year markets had considerable concern that the world’s investors would demand higher rates on US Treasuries. That has not proven true. Compared to problems other parts of the world, the EU specifically, the US remains a favored destination for capital. Initial Jobless claims on Thursday, though a weekly figure, will provide further insight to the unemployment picture. No recovery can sustain without employment. After the NFP report last Friday, the stall of this figure at 460,000 assigns some doubt to the recovery picture. Also on Thursday in the US are Leading Economic Indicators. This statistic was one of the first to turn positive at the start of the second quarter last year. From April 2009 until March this year it registered twelve consecutive months of expansion. April however was negative at -0.1%; 0.4% is expected. There should be considerable interest to see if the April result was an anomaly. CPI, industrial production, capacity utilization and housing starts will not provide much new information. Watch for developments in Europe. The dangers of the EMU and the euro are never far from traders thoughts. |