Risk assets really struggled yesterday as both investors and traders decided it was prudent to cash in some chips after a stellar first two months of the year.
European equities were off by around 2-3% on the day, treasury yields declined, high-beta currencies beat a hasty retreat and both the dollar and the Japanese yen were in the ascendancy. Financial stocks were spanked, especially those which actively participated in the LTRO. Video:
A variety of forces triggered the more circumspect mood including some heightened rhetoric towards Iran from Israeli Prime Minister Netanyahu, a lower official growth target from China and signs that some private sector bond-holders of Greek debt are reluctant to sign up to the debt swap.
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The IIF hit the headlines claiming that a Greek default risked a one trillion euro fallout. Also, in Europe the latest LTRO has been accompanied by a huge leap in use of the ECB’s deposit facility, which has now reached EUR 827bln.
Not surprisingly, the single currency fell back for a fifth straight day to near 1.31, while the Aussie lost 1% to 1.0550 at one stage. Interestingly, the gold price continued to suffer despite the urge to seek safety, the precious metal falling another 2.3% to USD 1,668 at one point. Spanish bonds underperformed dramatically, Rajoy’s fiscal defiance clearly a source of concern.
Commentary
Rajoy openly defies the EU. Spanish Prime Minister Rajoy deserves considerable credit for his defiant stance against Europe’s fiscal hawks. After Spain recorded a worse-than-expected budget deficit last year of 8.5% of GDP, Brussels had refused to countenance any adjustment to the 4.4% target it had laid out for the current year, despite various attempts by the new Spanish government to persuade the EU to reconsider. In response, Rajoy instead announced at the recent EU Summit his own deficit target of 5.8% of GDP for 2012, still a very tall order with the economy in recession and unemployment at 23%. Interestingly, the response at home to Rajoy’s resistance has been incredibly supportive. At the same time, Spain’s open mutiny over Europe’s fiscal dictats risks seriously undermining the newly-signed fiscal compact treaty before the ink has had a chance to dry. The Commission has now vowed to look at Spain’s case very closely – it will need to tread very carefully. Rajoy’s government has aggressively pursued both fiscal austerity and structural reform despite an immensely challenging political and financial environment. He needs Europe’s support and not intransigence. Fiscal orthodoxy has definitely been required in Europe but it always needs to be implemented with care or else it risks triggering a deadly decline into destructive depression.
Familiar forces on the yen. USD/JPY fell back yesterday after nearly three weeks of unrelenting gains. Increased risk appetite, together with the BoJ’s decision to further expand its balance sheet and also formally introduce an inflation target, have contributed to the yen’s losses. A widening of the 2Y US/Japan interest rate differential also provided the dollar with some assistance as US short-term rates rose. This widening has now faded somewhat, and so it is no surprise to see USD/JPY starting to struggle. The other issue is that we are approaching fiscal year-end in Japan, when repatriation flows are usually very much in evidence. This does not always spell gains for the yen, the trade-weighted yen having risen in March only once in the prior four years. In the background yesterday were further tensions surrounding Iran, both on the nuclear and inevitably the oil front, leading to a general softening of risk appetite as seen on the Kiwi, Aussie and also in stocks. The yen remains the standout of the majors so far this year, but if we do see a renewed period of struggling risk appetite then there could well be a strong desire for the yen to fall back into line with the pack, much to the frustration of the authorities which desperately want to see a weaker currency to support their much diminished competitive position in the region.
RBA contentment. Discernible in yesterday’s statement from the RBA announcing unchanged policy was a sense of underlying comfort with the current situation down under. On global growth, the RBA expects a below-trend pace in 2012, although not a deep downturn. In particular, Chinese growth is moderating but remains robust, whilst America is enjoying a moderate expansion. Domestically, growth is around trend whilst underlying inflation is in the middle of the RBA’s 2-3% target band. Australia’s central bank remains acutely conscious of the significant structural change occurring in the economy, with investment in the mining sector still very strong whilst domestic consumption is weak. The latter is weighing heavily on both house prices and employment. Looking ahead, the RBA clearly still has a bias towards easing. Although content to wait and see for now, “should demand conditions weaken materially, the inflation outlook would provide scope for easier monetary policy”. Our view is that demand will remain tentative over coming months, helping to ease inflationary pressures further. As such, we would be very surprised if official rates were not reduced again before mid-year. After reaching 1.08 last Thursday, the AUD has consistently been on the defensive with some acute selling evident again yesterday. The tone towards the Australian currency was not helped by a suggestion from a PBOC adviser that the renminbi would probably not be allowed to appreciate much further for a while. Suddenly, the Aussie is looking more vulnerable.
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