Euro crisis temporarily averted by ECB
LONDON, Sept 7 —A line may have been drawn under the seemingly endless euro crisis at long last but don’t confuse investor relief with the “animal spirits” of the market just yet.
What yesterday’s euro rescue plan from the European Central Bank does most clearly is allow investors a sharper focus on other world issues critical to the increasingly uncertain global economic cycle and, as the fog lifts, allow some fundamental and corporate analysis to replace crisis doublethink.
“This is a valuable purchase of time, even if at a reasonably high price. But it won’t make me buy or sell peripheral debt in Italy or Spain suddenly, for example, as it doesn’t in itself solve the underlying economic problems there,” said Jerry Webman, chief economist at New York-based OppenheimerFunds, which manages about US$176 billion of assets.
“But what (ECB chief Mario) Draghi has done by removing the threat of an immediate meltdown is to allow investors to take their eyes off southern Europe for the moment and ask what companies around the world are positioned to grow as of now, and look at fundamentals again to make some investment decisions.”
Corporate gems aside, the macro view certainly widens again from Europe over the rest of the month.
Next week alone, wobbling China offers its latest economic health check in a hail of August data and Federal Reserve policymakers decide whether more money printing is appropriate just as the US presidential election campaign hits top gear.
And that’s not to mention the series of follow-through euro events from Germany’s court ruling on the bloc’s new rescue fund, Greek bailout updates and Dutch elections.
But for markets paralyzed by the so-called “tail risk”, or outside chance, of a euro collapse over the past year, Draghi’s new government bond-buying framework dispels some of the worst nightmares of a systemic meltdown in Europe.
“The ECB has delivered what it promised. The market will eventually demand more but in the short term, it is satisfied. People are going to focus now on the US election and fiscal issues, and whether we will get QE,” said Murat Toprak, emerging markets strategist at HSBC in London.
Cumulative asset price moves since Draghi first mooted the ECB plan on July 26 is testament to the extent of this relief.
World stock markets have rallied more than 8 per cent to four-month peaks, with euro stocks booming almost 20 per cent to their highest since March and the euro currency up more than 4 per cent on the dollar.
More specifically, Spanish two-year government bond yields have been crushed by four full per centage points to less than 3 per cent. Italian two-year bond yields are down almost 3 per centage points to 2.4 per cent.
So, game over for fearful world investors? Well, not quite.
“The big game changer was July 26 as the market has simply been pricing huge euro tail risk that the ECB has now cut down,” said William de Vijlder, Chief Investment Officer at BNP Paribas Investment Partners — which has total assets of €513 billion (US$651 billion) under management.
“What we’ve done is to move from an inherently unstable investment regime into one that is still very challenging but at least we can see a point on the horizon where stability returns.”
Perhaps the biggest test of that will be auctions next week of the key safe-haven investments, 10-year US Treasury bonds and five-year German bunds, where yields have been creeping higher of late.
But de Vijlder said that while his funds might now play Spanish or Italian assets tactically, they would not yet consider structural overweights and the firm had not increased its overall global risk budget.
“For that we need to see a change in the cyclical picture worldwide.”
Next week could tell us quite a bit on that score.
The pulse of China’s economy will be recorded on Sunday and Monday with a slew of inflation, industrial, retail and trade data for August. The US equivalent of August inflation, industrial and retail data pops up today after yesterday’s Fed decision.
Reuters latest poll on Fed expectations put a 45 per cent chance on a QE3 announcement this month.
Opinion polls on the outcome of November’s presidential election are just as divided, with incumbent Democrat Barack Obama neck and neck with Republican challenger Mitt Romney.
But Webman at OppenheimerFunds reckons investors are unlikely to get meaningful signals from the race or eventual winner on the all-important fiscal policy issues until early next year. In the meantime, he said it would be better just to stay focused on the steady if unspectacular recovery, assuming monetary policy supports remain in place.
With Wall Street’s at four-year highs and having recorded its best year-to-date gains since 2003, there’s no shortage of optimism on that steady recovery persisting and recent data on housing, the service sector and consumption is encouraging.
But the August US employment report today showed a lower-than-expected 96,000 increase in payrolls during the month, reinforcing the picture of underwhelming growth at best.
“I’m a believer in a sustainable but weak recovery. With all the deleveraging from the credit excesses, it’s like the biblical seven lean years following seven years of plenty. But things are getting better slowly,” Webman said. — Reuters