A busy week so far brought along some disappointment as the US Fed Bank and Europe's ECB chose not to take immediate action. The decision was contrary to Draghi's pledge to do 'whatever it takes' to preserve the currency. In the US, the Fed made no bold promises prior to the FOMC meeting, but continued to state the obvious and remain cautionary in its assessment of the US economy.
The problems in the US are relatively stable to comprehend compared to the ticking time bomb in the Eurozone. As expected, the FOMC left rates unchanged at 0.25% and will remain near zero until late 2014. US savings continued to increase, consumer spending is flat, and income is slightly up. Consumer confidence came out higher than expected, which produced a mixed view of structural conditions. ISM came out lower than expected at 49.8 from 49.7, when expectations were higher. There seems to be a slight slow-down in spending and productivity, while consumers and businesses are holding onto cash, indicating higher levels of uncertainty.
The mixed reports out of the US stresses the importance of tomorrow's jobs numbers. The Fed stated that it will continue to asses unemployment reports for July and August. Some reports indicate Fed action during its September meeting if economic data disappoints. A good indicator going forward is the initial jobless claims reported today; coming out higher at 365K compared to the previous figure of 357K, still lower than expected. This could mean that expectations are a bit high, with job conditions worsening, but still not as bad as analysts expect. Tomorrow's expectations for non-farm payrolls are at 100K from 80K.
In Europe, Draghi hyped the markets and failed to act immediately. The US dollar rallied as expectations were clear, whereas the Euro declined sharply as more time was stalled. It was evident that the markets were expecting some action, as the Euro rallied prior to its slump. The ECB kept rates at 0.75%, but pledged to assist in bond purchasing. Plan A failed as Germany marked off on banking licenses, which call for unlimited power allowing countries to borrow funds from the ECB with government bonds as collateral. Plan B is to extend the ECB's purchasing power beyond legal limits (indirectly of course). ECB mechanisms such as the EFSF, ESM, and SMP (acronymns synonymous with the US securitization schemes; you get the picture) will intervene and purchase government debt in the primary markets to ease short term borrowing costs of member countries.
Draghi is essentially buying time as the ECB resumes its indirect buying process of buying short term to decrease 2yr bond yields, while increasing the long term 10 year bond yields. Artificially fueling the demand to allow eurozone countries some time to work through fiscal problems. However, the problems might take longer than expected, as data continues to disappoint.
The structural problems in the eurozone are severe, and the bond buying programs cannot persist any longer. Germany will surely not allow this to continue while governments fail to correct structural issues amid tight time constraints. Austerity is tough to execute politically, and it deters growth. Furthermore, with no growth, bond investors are demanding higher yields to compensate for the risk. The unintended consequence is that the ECB might be fueling the downward spiral.
Soaring yields are hurting Spain and Italy. As government leaders try to exert some fiscal authority, banks and businesses are busy fleeing their home country. In Spain, capital outflows quadrupled in May to 41.3 billion euros, with 163 billion euros left in the country. Domestic banks are sending money abroad at faster rates. Spanish bank Bankia required a bailout in May. Greece is experiencing deposit runs, and its fate is ultimately in the hands of the Troika (the three organizations that have power over Greece's future - EC, IMF, and ECB). Meanwhile, US Treasuries benefit from the global demand for safety from Europe.
Pay attention to tomorrow's jobs numbers in the US. 'Slower growth' seems to be the norm, as expectations for an economic pick-up are high. Failure to meet these standards could call for some stimulus. Europe has a lot of work to do regarding long term growth. Expect short term purchasing to continue, and perhaps some relief for Spain. Greece might come back to the forefront, as it was quickly dismissed by Draghi today, indicating that the Troika might be in talks of what to do about the failed outlier. After a period of stalling, Europe will need to make tough decisions by year end.
No comments:
Post a Comment