Monday was all about the re-pricing of risk. That’s not such a bad thing given that there were signs that markets were getting complacent once again. The VIX measure of equity market volatility is perhaps the best measure of this, in light of its liquidity. This was nudging below the 15.0 level towards the end of last month, a level that has not been seen on a sustained basis since the late 2006 and the early part of 2007 (and less than 0.5% of the time since September 2008). We now know, in part with the benefit of hindsight, that markets were massively under-pricing risk at that time. Therefore, the fact that the VIX is now above 20 and the dollar has regained some of its poise should be broadly welcomed as a sign that investors are being a little more realistic regarding the underlying risks to the global economy and eurozone sovereign risk in particular.
Guest post by FXPro
Commentary
UK banking sector still fragile. Moody’s has confirmed overnight rumours that 14 UK banks and building societies have been put on ratings review. The issue is the withdrawal of government support measures, including lending guarantees that are due to expire this year. This comes after Bank’s were yesterday accused of not lending enough under government agreements from earlier this year. It’s another one of those underlying risks to be wary of.
Moody’s further confirms re-profiling divide. Moody’s has also confirmed that it would view any ‘re-profiling’ of Greek debt as a default, following on from the same assessment from Fitch on Monday. Politicians are using this term as a way of avoiding the ‘d’ word, but it’s with the credit default swap market (CDS) where the biggest issue lies, as for now it’s not clear that such a delay in repaying month would be termed a ‘credit event’, resulting in a pay out to those that have sought to protect themselves from a Greek default.
The dollar’s merry month of May. Any sense that the dollar is set to lose its status as the world’s reserve currency any time soon has been rendered premature by this month’s stunning turnaround. It remains to be seen how much further the greenback can climb, but even so the nearly 5% increase in the dollar index in a little more than two weeks is certainly noteworthy. Widespread risk aversion has been the major explanation for the dollar’s sudden gains, amidst renewed concerns over Europe’s sovereign debt crisis and fears that the global recovery is losing steam. The EUR itself has lost 8 big figures since the early days of this month, while the Aussie briefly fell through 1.05 yesterday after reaching a new post-float high above 1.10 not long ago. major European bourses were down by around 2% today, while Brent crude fell another 3% t0 $109, a loss of $17 since the 1st of May.
Sterling’s change of emphasis. The firmer dollar environment that is again in evidence early this week pressured sterling, nudging below the 1.61 level against the dollar and only just holding its own against a fairly beleaguered euro. Even some relatively hawkish comments from the BoE’s Chief Economist Dale over the weekend were not sufficient to entice some buyers. He’s been voting for higher rates since February, being the only internal Bank member to side with the two external members (Weale and Sentance) in opting for tighter policy. Whilst he remains concerned about the recovery, he appeared even more concerned with inflation. Still, even though he has been voting for higher rates, he acknowledged that “things will change and the economy will evolve differently”. In other words, it was very unlikely that the Bank’s central scenario would prove to be correct, given the higher than normal level of uncertainty. Sterling though appears to be struggling to get excited by the rate story. This proved to be one of the main drivers during the first quarter, but weak growth and the lack of strength in forward looking indicators undermined the case for a near-term rate increase. The positive reaction to last week’s higher than expected inflation data proved to be rather transitory and there is a perception that the currency market is more worrying about the impact on real incomes and household spending from higher inflation, rather than feeding from the likelihood for higher rates. If this change in emphasis is sustained, then it could prove to be a tough rest of the quarter for the pound.
Another debt crisis, this time in the US. All eyes may be on Europe’s debt crisis right now, but if a solution is found in coming weeks then attention could very rapidly switch to America’s trials and tribulations over raising their $14.3trln debt limit. The US Treasury has already warned that they will run out of short term fudges to prevent the debt limit from being breached by August 2nd. The GOP’s Paul Ryan, the Chairman of the House Budget Committee and the author of a comprehensive budget plan extensively debated over recent weeks, suggested over the weekend that it could very well take another couple of months before a deal is done. Ryan proposes to chop spending by $6bn and to privatise Medicare (the health care program for the elderly). Republicans are claiming that they will not vote for an increase in the debt limit without agreement on a substantive spending reduction program. Traders need to remain cognisant of this issue, because it is one that markets are bound to return to if interest in Europe’s own debt crisis wanes.
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