Unfortunately, in financial markets at least, it is rarely the merry month of May. Last week was another sea of red, with equity markets on the slide, high-beta currencies heading south and core G4 bond yields declining. Spanish equities were singled out for the harshest treatment, falling another 3%, with the financials again hard hit.
The Aussie is back at parity, the euro is under 1.29, and cable is near 1.6050. German 10yr bund yields fell below 1.5%, at the same time as the 10yr yield in Spain rose above 6.0%. Apart from the deteriorating political situation in Greece and the equally disturbing Spanish banking predicament, markets were rattled by the massive loss recorded by one of the units of J.P.Morgan.
Guest post by Forex Broker FxPro
Overnight, the mood stabilised slightly after China decided to reduce the bank reserve requirement (RRR) by 50bp (see below). Worryingly, many of those forces which were so unsettling last week are still in play, including growing speculation that Greece may well leave the euro before too long.
China needs much more than a cut in the RRR. Although last night’s 50bp reduction in the RRR is commendable, it is clear that policy-makers in China must sanction a further easing of financial conditions in response to mounting evidence that the economy is really struggling. Growth in industrial production fell back to high single digits in YoY terms last month, the weakest performance in three years, retail sales were softer than expected and home sales fell 16% MoM in April. Earlier in the week, the Customs Bureau reported that there was essentially zero growth in imports in the year ended April. Also, power generation in China has slowed appreciably in recent months, again a portent of weakening demand. Inflation is moderating as well – producer prices actually fell in YoY terms in April. Rather than lowering rates at this point, any further easing of monetary conditions will likely consist of even lower reserve requirements, more directed policy initiatives (such as reduced mortgage rates for first-home buyers), a resistance to currency appreciation, open market operations and fiscal initiatives. Notwithstanding the apparent weakening in the housing sector, Premier Wen Jiabao has resolutely pronounced that the curbs on multiple ownership and restrictions on mortgages will continue for a while yet. Although policy officials recognise that the growth risks right now are more serious than those posed by inflation, nevertheless and correctly they are waiting for further evidence that the inflation genie has been placed firmly back into the bottle before implementing a reduction in rates.
Germany prospers while the rest of Europe burns. These days Germany risks not just political isolation within Europe but also economic isolation. While southern Europe burns (at least on a financial level), the German economy continues to move ahead. Apart from Greece, which frankly has never been far away from the headlines at any time over the past couple of years, Spain is in the markets’ crosshairs at the present time. It appears that the mandarins in Brussels have figured out that the situation in Spain is now so bad that they need to cut it some slack on the achievement of future fiscal targets in exchange for an independent audit of the banking sector and greater supervision of the fiscal affairs of the regions. In contrast, Germany is wondering how to respond to very easy credit conditions and an economy which is still recording respectable growth despite the pain and suffering being experienced elsewhere on the Continent. According to a council of tax experts in the country, government tax receipts for the current calendar year are expected to be EUR 30bn (around 1% of GDP) higher than previously anticipated. A nice problem to have, although one bound to trigger envy and enmity amongst Germany’s EU partners.
The slippery slide in gold. The price action on gold continues to catch the attention. The sustained move below the USD 1,600 level means that it’s now only just in positive territory for the year-to-date; last week was the worst weekly performance of 2012. Furthermore, year-to-date performance has been the weakest for seven years. As we pointed out last week, a fair bit of this weakness in gold can be put down to the firmer tone we are seeing in the dollar. But that’s not the whole story, with gold also weaker in most other currencies over the past week. The interesting thing is that there are less signs of physical dumping of gold. ETF holdings in physical gold have being falling since mid-March but, according to Bloomberg data, holdings have steadied so far this month. However, this is where the longer-term fate of gold may well lie. There remains a strong cohort of investors which have stuck with gold throughout this financial crisis and, in dollar terms at least, this has proven to be a decent strategy. But should gold move into negative territory, then it’s going to be that much harder for the ‘stick with gold’ strategy to retain legs. Even more so than for FX, finding a fundamental valuation for gold is far from a stringent science, not least because there is no income flow to discount, in contrast to bonds, equities (and FX with carry). The price action in gold suggests a fundamental change in the risk tolerance of investors. Keep an eye on official holdings though. It is early days, but data from the World Gold Council suggests the pace of global official purchases has slowed markedly so far this year (data for first two months), running at one fifth of the pace seen in the second half of 2011.