Irish Cheer Lifts Markets
- Agreement on Irish Rescue Drives Relief Rally
- Short Term Relief, Long Term Problems for the Euro
- Strange Occurrences in the Treasury Market
- Liquidity Freeze Ahead
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Agreement on Irish Rescue Drives Relief Rally
Worldwide financial markets said "Slàinte!" last night after European finance ministers accepted an Irish application for rescue funding.
Global asset prices experienced a relief rally over the trading cycle after Irish Prime Minister Brian Cowen said "The European authorities have agreed to our request. A formal process of negotiation will now commence that will lead to the provision of assistance on the basis of a programme to be negotiated by the government with the European Commission and the International Monetary Fund, in liaison with the European Central Bank. I expect that agreement to be finalised shortly, within the next few weeks".
The creation of a fund totalling close to €100 billion is expected, and will be largely devoted to bailing out the large Irish banks, as opposed to providing budgetary support for the government.
Rising prospects for a rescue removed uncertainty in the debt and currency markets. The US dollar gained slightly on a trade weighted basis, and the euro climbed almost a cent over the weekend. Equity bourses around the planet rose as traders turned optimistic and commodities snapped a four day losing streak, with crude oil moving back toward the $83 mark and industrial metals such as copper, aluminum, zinc, tin, and nickel all seeing moderate gains.
The Canadian dollar gained slightly as the European political environment improved, but remains under pressure. Last week's announcement that Chinese authorities are acting decisively to dampen inflation pressures has had a cooling effect on the commodity complex and on growth sensitive currencies such as the CAD and the AUD. Copper imports into China during September were 30% lower than last year, and traders fear that further declines will come as policymakers take steps to tighten monetary conditions and deflate speculative bubbles.
Short Term Relief, Long Term Problems for the Euro
The Irish rescue agreement certainly takes some of the negative pressure off the common currency in the near term, and has bolstered confidence in the European Union's problem fighting mechanisms. However, constantly lurching from crisis to crisis is not a recipe for currency stability or strength, and there is a strong risk that the euro simply grinds lower in the longer term.
Ireland's formal request is the second since the financial crisis began, after Greece accepted a bailout earlier this year. Portugal and Spain are next in line on the bond vigilantes' hit lists, and renewed tension in the European debt markets remains a strong likelihood in the months to come.
Thus far, the European Union's ad hoc approach has been successful in quelling specific disturbances, but in the fiscally pragmatic northern countries, the political will required to fund these rescues is rapidly ebbing. Investors and traders remain deeply uncertain about the process that will be followed in future circumstances, and will remain so until a solution can be found that puts individual countries on the path to fiscal sustainability and sets out a framework for future rescues.
Strange Occurrences in the Treasury Market
In an interesting development that may have a significant impact on the currency markets, interest rates on US government instruments have actually risen since the Federal Reserve declared its intention to pour $600 billion into the market in an attempt to push yields down. The Fed's bond buying programme should have depressed interest rates as investors anticipated a flood of money into the market, but the diametric opposite has occurred in the weeks since the announcement. 30 year yields are now at levels last seen in May.
To an extent, the rise in yields has been driven by profit taking. Traders who had bet on a decline earlier in the year are now taking their positions off, realizing their profits and reducing their exposures.
At the same time, the market has seen a fundamental shift in expectations. Only a month ago, investors were concerned about an effectively unlimited cycle of money printing by the Federal Reserve. Since then, strident domestic and international political opposition has forced Fed officials onto the defensive. At the same time, Fed policymakers themselves have expressed growing doubts about whether further quantitative easing measures would have any appreciable effect on growth. These pressures have significantly lowered the likelihood of yet another round of easing measures, and investors are now looking toward the risks and opportunities that aren't priced in – namely, the tightening that must eventually occur, and the strong possibility that the US economy continues to grow, forcing yields upward.
The US dollar has gained against most of the majors over the last two weeks as investors sought a safe haven from troubles in Europe, redeployed capital in domestic markets and closed carry trades. Federal Reserve Chairman Ben Bernanke said on Friday, "The best way to continue to deliver the strong economic fundamentals that underpin the value of the dollar, as well as to support the global recovery, is through policies that lead to a resumption of robust growth in a context of price stability in the United States". The currency markets seem to agree…
Liquidity Freeze Ahead
The data calendar for the week ahead is relatively sparse. Wednesday brings the University of Michigan consumer sentiment index in the United States, which has often moved markets over the last few months. Of greater importance will be the Federal Open Market Committee minutes scheduled for release on Wednesday afternoon. These will provide more insight into the decision making process that led to last month's announcement of further monetary easing measures. Although members of the policymaking committee have been fairly communicative, the potential for surprises still exists and traders will be watching closely.
Liquidity will begin to drain from the foreign exchange markets in advance of American Thanksgiving on Thursday, followed by Black Friday (the anniversary of the 1869 stock market crash).
Something to remember here is that while low liquidity conditions are not generally favourable for professional traders who trade in and out of their positions all day long, erratic price movements and wider trading ranges can open up some excellent opportunities for corporate hedgers. Talk to your trading teams about strategies – they'll help you determine optimum trigger levels as the week evolves.
Happy trading!
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