With no fresh inspiration arising from the latest meeting of eurozone finance ministers and Luxembourg’s Prime Minister Jean-Claude Juncker suggesting that the troika will not complete their assessment on whether Greece has satisfied the conditions for the next tranche of bailout money until mid-November, the euro was under fresh assault yesterday. Indeed, yesterday was a truly dreadful day for the single currency – it fell from near 1.34 near the middle of the London session to a low of 1.3165 early in Asian trading.
Rumours (subsequently denied) were swirling around yesterday claiming that Greek Prime Minister Papandreou had offered to resign. And Didier Reynders, Belgium’s finance minister, intimated that Greece has enough money to survive for another six weeks. Not surprisingly, the repulsion for risk has continued overnight, with the dollar in hot demand, and both equities and bond yields under further downward pressure. The S&P 500 ended down nearly 3% at 1,099, a 13m low, while the Kospi was suspended for a time overnight after a 5% decline.
Guest post by FxPro
Commentary
The dangers of defensiveness. Very few would argue with the contention that both investors and traders have whipped up a vortex of fear in recent weeks over various issues, principal among them Europe’s debt crisis and the clear downturn in growth momentum across both the developed and developing world. At a time of heightened uncertainty, especially where the financial risks are potentially very significant, the desire to seek sanctuary on the sidelines is perfectly understandable. Equities and commodities have been abandoned over the past couple of months in favour of cash, bonds and the dollar, at a time when the urge to deleverage was already well-established. The MSCI World free index of global equities lost 18% last quarter, the yield on the US 10yr note fell more than 100bp to below 2.0% and holdings of dollar cash soared. However, the flip-side of this extreme pessimism is that it can also wreak havoc, especially when this impulse is unleashed in crowded company. Excessive fear clouds the dispassion required to undertake profitable investment and trading decisions; it is especially dangerous for an individual if they are losing their heads at the same time as others. There are numerous ways to get a sense for how frightened market participants really are right now. For instance, the VIX index (which measures the implied volatility of the S&P 500 futures contract) has averaged 36.6 over the past two months, a very elevated level. That said, to paraphrase Keynes, the market can remain irrational for much longer than a trader or investor remains solvent. Back in late 2008 and early 2009 for example, the VIX remained above 40 for essentially the entire period from late September 2008 until early April of the following year. In addition, the equity risk premium is now very large; in the US, the forward earnings yield for the S&P 500 of 9.8% is 800bp above the risk-free long term government note yield of 1.8%, which implies that equities are tremendously oversold relative to bonds. In forex markets, similarly heightened uncertainty prevails – one-month implied volatility for the single currency is now 17, some 40% above the two-year average. Traders are now exceptionally short in terms of their euro positioning, according to the latest CFTC data. Indeed, they have not been this negative since the second quarter of last year, immediately prior to a huge period of outperformance for the single currency. Oftentimes, overdeveloped defensiveness can be just as destructive as excessive hubris and optimism. As such, it is entirely possible that the collective psychological desire to hide under the duvet covers right now may well end up being regretted.
China’s property pickle. Obviously Europe’s admirable attempt at self-destruction continues to dominate the forex market’s headspace, for very good reasons. However, a secondary story is emerging which is potentially just as important, namely the bursting of China’s property bubble. Last week, S&P put out a warning suggesting that the vast majority of the developers that they cover in China would struggle to survive should sales next year fall by more than 10%. Lenders in China have been cutting credit, consistent with the desire of policy-makers to reduce price pressures in the world’s second largest economy. The concern of many investors is how much (or little) they would get paid in the event of a default. In China, it is fair to say that property law does not operate in the same way as it typically does in the West. In response to tighter credit and higher rates, developers are being forced to reduce prices, in many cases significantly. Some investors, seeking to find any proxy hedge for Chinese property, have taken to selling the Hang Seng and the South Korean won and shorting their bonds. Indeed, this activity helps to account for a good part of the recent softness in the South Korean currency, much to the chagrin of the BoK. In Hong Kong, the Hang Seng property index has collapsed by 38% since early January. China’s property woes are certainly having a bearing on the performance of Asian currencies and equities.
The pound – not pretty but effective. Much like the performance of the English rugby team at this year’s World Cup, the recent track record of the pound has not been pretty, but effective. Just like other major currencies, it has lost ground against the new darling of forex markets, the dollar – cable is now just below 1.55, down from the mid 1.60s six weeks ago. And against the Japanese yen, it is at 118.5, down from 140 back in April. However, the pound has made creditable progress against all other majors. With the euro under enormous strain amidst mounting sovereign debt and banking sector concerns, sterling has been favoured by some traders and investors looking to reduce their single currency exposure. EUR/GBP is now 0.8545, a seven-month low. The pound has also comfortably outperformed the likes of the Australian dollar, the Swiss franc and other high-beta currencies over recent months. Sterling’s ability to outshine most other majors is not a surprise, despite the dire state of the national economy. The Chancellor’s program of fiscal austerity continues to win plaudits from the UK’s creditors, and the currency is attracting some buying interest because high net worth individuals regard the London property market as something of a safe-haven. In the new FX pecking order, the pound might continue to occupy an elevated position for a while yet.
UK Chancellor further blurs the fiscal and monetary policy divide. In a relatively small section of his speech, the UK Chancellor yesterday announced that the Treasury is working on a process known as ‘credit easing’, designed to get more lending going in the economy. Note that this is a little different to what US Fed Chairman Bernanke termed ‘credit easing’ when the Fed first pursued quantitative easing, so we’re already in a world of mixed metaphors. Osborne’s version involves the public sector buying bonds issued by companies and introducing means by which smaller business loans would be re-packaged and sold on. The Conservatives talked about such a measure whilst in opposition (under the title ‘National Loans Guarantee Scheme’) and with the economy slowing again and the failure to nudge banks into lending more (project Merlin), it now appears that this is going to be put on a formal policy footing. Ultimately the aim is to both increase the availability of credit to small business and reduce its cost. Details are scant at this stage, but from what can be gleaned so far we can safely say three things. Firstly, just as with the leveraging up of the EFSF, it’s another example of how solutions bear a striking resemblance some of the causes of the crisis, with the implication of the government proposal being a re-packaging and selling of small business loans (i.e. securitisation). Secondly, there’s an even greater blurring of the lines between fiscal and monetary policy, with the Bank’s undertaking of QE designed to achieve a similar result (lower borrowing costs), but by different means. Thirdly, markets aren’t quite sure what to make of it. Does it mean things are worse than feared as the government gets more involved or will it mean that the recovery is going to come sooner that would otherwise be the case? And does it reduce the chance of QE2 from the Bank of England as early as this week? So far, there’s not enough detail to answer these questions, hence the limited market reaction, but the impact could be quite significant further down the line.
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