October 14th, 2013
by Cliff Wachtel, FX Empire
This past week's top market drivers and lessons should explain much about the coming week.
The Key Points
- Day 6-10 of partial US Government Shutdown , impending October 17 debt ceiling hit, and ramifications
- Monday and Tuesday: Markets moving with speculation on US budget deadlock resolution. Successful Italian and Spanish bond sales signal EU crisis remains dormant, aided by US budget turmoil, which both distracts markets from EU woes and narrows 'stability gap' between US and EU in minds of investors.
- Wednesday to Friday: Yellen Appointment, Signs of US Debt Deal Lift Most Global Indexes, Risk Currencies
- Other Noteworthy:
- Signs of life from Greek economy?
- US earnings season results not a factor
- IMF cuts China and East Asia growth estimates and commodity price estimates
- Lessons & Conclusions - these will help explain the coming week
Lessons For The Coming Week: 3 Big Market Movers To Watch
Let's review what last week taught us about the coming week and beyond. First, what's really driving most asset markets?
1. Speculation on US Budget Resolution and What's At Stake
Most global asset markets moved with fear or hope regarding the chances for the US reaching a budget deal that both ends the shutdown of non-essential Federal government services and eliminates risk of any near term US default.
Nothing makes that clearer than set of four hour charts of major global stock indexes shown below. Just look at how prices were generally falling October 7-8, then suddenly started rising Wednesday through Friday.
Four Hour Charts of Leading Global Stock Indexes, Including Week of Oct 6-11:
- Left Column Top-Bottom: S&P 500, FTSE 100, DAX 30,
- Center Column Top-Bottom: CAC 40, DJ EUR 50, Nikkei 225,
- Right Column Top-Bottom: China A50, HSI, MSCI Taiwan,
As we discuss in depth here, leading global stock index trends are a handy quick view of market sentiment, and how both risk and safe haven assets, as well as risk and safety currencies should be moving at a given time.
Why the change in global risk appetite?
From Wednesday to Friday there was growing belief that some kind of deal would be reached to raise the debt ceiling enough to provide 1-2 months to conclude a more durable deal. The current point of contention is whether the government shutdown continues. The Republicans (who control the House of Representatives) want it to continue in order to pressure the President and his Democratic allies (who control the Senate), who in turn want the more borrowing allowed in order to lift the shutdown.
What's Driving That Trend Change?
Markets jumped on reduced risk of all of the following:
All kinds of bad things can happen to the US and global economy if a deal isn't reached very soon. October 17th is the day the US is supposed to reach its borrowing limits, though as we'll see below, there's some wiggle time. See below for more on that.
For those not familiar with the range of things that are and are not scaring markets and making the US budget battle the key market driver, see here for an in-depth look. For those who are, here's just a quick listing.
- Chaos: This is really the big one, both in terms of market uncertainty (so a big selloff is expected by many if October 17 passes with no deal imminent) and the reality of how the US government continues to function. With its borrowing capacity limited, the U.S. Treasury Department may go into default and eventually be forced to prioritize its payments. However it's far from clear that there is any such plan extant on how to prioritize payments, nor is it clear that even if the Treasury had one, it would be legal.
- Wild Market Volatility: That much uncertainty and risk causes selloffs, which, if given a few days, can take on a life of their own as program trades kick in. Big time.
- Hit to GDP grows with each day.
- Damage to consumer confidence that could hurt retail sales during the vital Christmas shopping season.
- Additional damage to US credibility and credit rating.
- Rising US borrowing costs.
- Continued Battering For the USD, further hurting GDP.
- Government shutdown means blackout on federal government supplied economic data.
I could come up with a few more, but that's the basic list. Again, see here for a more detailed explanation.
As of this writing, there is still no deal; however markets remain calm in the assumption that Congress wouldn't be so stupid as to let the deadlock drag on long enough to cause significant damage or a default. That confidence erodes with each passing day.
Don't Be Surprised If There Is No Deal By October 17th
So what terrible things befall us on October 17th if there's no deal? Probably not much, actually, at least not right away.
This is when the US is expected to hit the debt ceiling and be unable to issue more debt. However the US probably has another week before it must actually default, because the Treasury keeps an extra $30 bln around for emergencies. This is important to know because given the current brinksmanship both sides are using, a deal may come only when Congress truly believes it's the last minute. Only then can both sides turn to their supporters eyes aimed piously skyward, and claim they had to make sacrifices for the greater good.
See here for details
The Most Likely Outcome?
The consensus appears to be that at minimum we get some short term deal that gives Congress a month or two to work out a longer term deal. If so, that likely means some kind of short traders' relief rally, followed by a return of bearish pressure on markets is repeated as yet another deadline inches closer. Whether or not that fear will be felt in the weeks ahead would depend on whether there are other positive or negative surprises (earnings, new sentiment on the size and duration of QE, an new EU crisis, etc.).
2. Yellin Appointment to Fed Chair
News that Janet Yellin would indeed replace Ben Bernanke as Fed Chair...person also helped lift markets from Wednesday to Friday
She's seen as the most dovish FOMC member and thus expected to maintain the Fed's bond buying program and defer and tapering until US economic data shows clearer economic improvement. Some of the obvious ramifications include:
- That's seen as good for stocks and other risk asset markets that are seen as dependent on continued QE for further moves higher.
- It's bad for the USD, as the QE is seen as threatening dilutive inflation. Inflation hasn't been a problem thus far because subdued economic growth has kept cash sitting in the banks rather than circulating via new loans.
- It may prove very good for bonds and dividend stocks (MLPs REITs, Utilities), both of with saw steep selloffs in times of taper fears. If data continues to suggest continued weakness yield starved investors will be more likely to start bidding these back to pre-taper levels.
- She appears ready to keep markets stable if Congress can't reach a deal. In her acceptance speech she appeared to include a third mandate for the Fed:
"I pledge to do my utmost to keep that trust and meet the great responsibilities that Congress has entrusted to the Federal Reserve-to promote maximum employment, stable prices, and a strong and stable financial system."
Read: "Sure, everyone talks about the Fed's mandate to promote jobs and stable prices, but how the heck do you do that if the U.S. runs out of cash and defaults because we've got a bunch of jerks in Congress?! See here for more on this.
3. Spain, Italy Bond Sales
On Wednesday both Spain and Italy held successful bond sales. European markets were mostly lower, but sometimes the biggest market movers are the things that don't happen. These bond sales remain barometers of EU debt anxiety, so signals of calm from the too-big-to-fail-or-bail club kept markets from plunging and helped set up the rally that would start in the US that day and continue through the rest of the week.
Not Market Moving But Noteworthy
This matters as Greece remains the most likely default and contagion risk spot, so what happens there matters for the dormant-but-far-from-resolved EU debt and banking crisis.
Prominent hedge fund boss John Paulson (right on US housing crisis, wrong on gold) announced that he's a believer in the Greek bank recovery. We hope he does better with that than he did with gold.
Also this week Greece announced that:
- It has forecast that its economy will rebound to grow by 0.6% in 2014 vs. a contraction of 4% in 2013, due to a recovery in investment, exports and tourism.
- It expects a of 1.6% of GDP primary budget surplus next year, and hopes it can return to bond markets in the latter part of 2014.
Ok, neither Paulson nor Greece is exactly on a roll with their predictions, Paulson blowing a wad of cash on long gold positions and Greece just being generally overoptimistic.
US earnings season results not a factor thus far
Earnings announcements after the market close Tuesday by Alcoa and Yum! Brands marked the official start of Q3 US earnings season, but these had no noticeable effect on markets, as Alcoa beat estimates, (AA), Yum! Brands missed(YUM), so their combined impact was neutral and thus left markets focused on the US budget debate and risks implied. Both stocks are global bellwethers, YUM for consumer consumer/discretionary stocks, AA for global industrial activity.
Of course earnings season's main influence on global markets occurs in weeks 2 and 3, which are up ahead, as these set the overall tone for how Q3 went for earnings.
IMF cuts China and East Asia growth estimates and commodity price estimates
This is related to the above, as both firms feel the effects of a slowdown in these areas.
1. Judgment Day Deferred
We continue to agree with the consensus view that at least a temporary US budget deal will happen to raise the debt ceiling and so avoid all the nasty things that might happen as noted above.
We may well be replaying this crisis in a month or so, in fact the more lasting lesson of the week may concern our new Fed Chairperson, Madame Fed Chairman, or whatever term becomes most used.
2. Markets: "Dammit, Janet, I Love You....."
The river was deep but I swam it (Janet)
The future is ours so let's plan it (Janet)
So please, don't tell me to can it (Janet)
I've one thing to say and that's Dammit, Janet, I love you
(Lyrics: Dammit Janet, Film: Rocky Horror Picture Show)
As noted above, the new Fed head is expected to keep QE around until US economic data indicates a clear and sustainable return to growth. In other words, the big support for risk assets, QE, may yet be around for a while. As that's still seen as the primary prop for risk asset prices, she's bullish for risk assets.
3. There And Back Again
That means we're right back where we were before the latest US budget crisis.
Markets won't be reacting to data directly, but more reacting to how they think the Fed will react to data. So expect more days of markets being
- Down in response to good data that raises expectations about the pace and timing of a QE taper.
- Down on really bad news that suggests QE isn't helping any more
- Up when news is good, but not good enough to taper, etc.
That's it for last week's lessons about what's likely to be driving markets this week. Please see our follow up article what else is likely to be moving global markets next week.
DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER