The weekend summit of EU leaders is officially now nothing more than a weekend bonding session as all hopes of an agreement on the EFSF rescue fund have been dashed. There is now talk of a second summit in the middle of next week, but exactly what is going to change between now and then is far from clear.
We talked earlier in the week about the fact that the EFSF expansion would likely cost France its triple-A rating, which in turn could well see a downgrade of the EFSF. This is the financial vortex that Europe finds itself and there is no easy escape.
Guest post by FxPro
Commentary
China is not immune. Abundantly clear in recent times is that investors harbour serious concerns over China. Mid-week, the Shanghai Composite index fell another 2% to its lowest level since March 2009. For the year-to-date, this index is down 17%, which is in line with the average drop of the major emerging bourses for the year thus far. Interestingly the Hang Seng, which many foreign investors use as a proxy for China, has dropped 22% in 2011. Shares in materials companies have plunged this week amidst heightened fears that the pace of growth both domestically and internationally is slowing markedly. The Civil Aviation Administration of China reported earlier this week that international cargo is weak, and that for 2011 both cargo and mail volumes will be unchanged from 2010, much lower than its previous estimate of 12% growth. Both money supply and lending growth have weakened, auto demand likewise and export growth is much softer. Property prices in many major cities are declining. These days, not even China is immune.
The creaking euro money market. There’s a fairly simple way to illustrate just how fractured the eurozone money market is becoming month-by-month. More banks are depositing cash at the ECB (for a 0.75% rate), than at the start of recent maintenance periods which run for one month and are the period over which banks have to meet their minimum reserves requirements (averaged over the period). At the same time, the money being lent by the ECB (at a 2.25% rate) to banks that can’t obtain funding in the money markets is higher than previous maintenance periods. This is the most vivid illustration of just how much the eurozone money markets are coming under increasing stress. It’s clear that there is an ever greater suspicion about bank balance sheets at this time, coupled with the fear that banks are going to have to raise increasing amounts of capital over coming months by means that have yet to be determined by eurozone leaders. Meanwhile, year-end approaches which, even before the credit crisis, has always been a time when banks have bolstered their balance sheets and market funding has become that bit tighter. Combine this with what we have seen on the ECB’s bond-buying program and the pressure for the ECB to take a more involved role in the EFSF, then the above is just another measure of the extent of the ECB’s (mostly reluctant) involvement in the sovereign crisis.
Commodities and the European banking crisis. As so often occurs during a crisis, a multitude of unforeseen forces are unleashed which end up making the situation much worse. Unfortunately, Europe’s sovereign debt and banking crisis is now resulting in numerous unintended consequences, especially in the commodities space. In terms of obvious first-order effects, the marked tightening of financial conditions and the weakening growth picture in Europe is restraining demand for imports from the emerging world, especially Asia. Not surprisingly, commodities-demand has also been dragged down. Investors, cognisant of the risks of weaker growth both in Europe and throughout the emerging world, have also sharply reduced their exposure to high-beta assets such as commodities over the past few months. Rather pernicious is growing evidence that Europe’s banking crisis is impinging severely on trade finance. French banks such as BNP Paribas, SocGen and Credit Agricole are the main financiers of the big commodity trading houses, many of which are operated out of Switzerland. In recent weeks, as these lenders engage in significant asset contraction, they are reducing the availability of credit, and raising its cost. Some of these French banks have confirmed that winding back commodity trade finance is definitely part of their efforts to deleverage their balance sheets. Three years ago, it was a freeze in trade lending which slowed global trade flows to a virtual crawl. Thankfully, the major trade financing players have more diversified funding sources these days, but certainly some of the medium and smaller-sized players will be vulnerable. For commodities, it is yet another factor that is placing downward pressure on prices. Both copper and aluminium prices have fallen more than 20% in recent months, and the iron ore price has dropped 13% in the last eight trading sessions. Gold is looking suspect as well – earlier this week, it was threatening USD 1,700, but has since dropped back to near USD 1,600. For high-beta currencies such as the Aussie, the downward pressure on commodities remains a serious risk.
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