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Irish Rescue Fails to Boost Sentiment
- Markets Calmer, But Still Pessimistic
- Korean Crisis Fades
- US Growth Promising for Canada
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Markets Calmer, But Still Pessimistic
Crisis in the sovereign debt markets was averted once again over the weekend, when European Union finance ministers signed off on a €85 billion rescue package for Ireland and outlined an agreement to build a permanent mechanism for dealing with future crises. Greece's "emergency loans" were also renegotiated, so that it will have an additional four and a half years to repay the €110 billion borrowed earlier this year.
In contrast with the wildly positive reaction to the Greek bailout earlier this year, the euro has actually fallen slightly at the time of writing. The currency is now sitting at a two month low against the US dollar, and the cost of insuring Portuguese and Spanish debt against default has jumped upwards.
The rescue package will be split into two main components - around €50 billion will be devoted to supporting Irish government finances for the next four years as austerity measures bite into growth, and €35 billion will be used to shore up Ireland's banking system.
The proposed "European stabilization mechanism" would replace the current €440 billion rescue fund, which is set to expire in 2013. Acceding to German demands for greater accountability from lenders themselves, the agreement would require European governments to attach clauses to debt issued beyond 2013, involving private creditors in any future debt restructuring.
In essence, lenders may be forced to realize losses on bonds purchased after 2013 if the borrowing countries enter default. This is expected to force lenders to be much more cautious about who they lend money to, and what yields they require for doing so. This goes a long way toward resolving one of the major logical inconsistencies associated with the common currency area – and raises the distinct possibility that bondholders will eventually take losses on their holdings.
Portugal is due to issue bills on Wednesday while Spain will sell three year paper on Thursday. Oversubscription would indicate that investors are feeling more comfortable, while anemic demand for these instruments could signal that contagion is spreading through the euro-zone debt markets.
The markets are sensing that a resolution to Europe's problems has simply been delayed once again - and with the threat of eventual losses looming over the market, the peripheral economies are squarely in the sights of the bond market vigilantes. The history of debt crises would suggest that speculators will now focus their attentions on the weak members of the flock, making it very likely that further shocks are on their way in the weeks and months ahead.
Korean Crisis Fades
Military exercises between US and South Korean forces in the Yellow Sea close to North Korea's coastline kept the simmering conflict in the headlines and on the minds of foreign exchange traders over the weekend.
However, with a 50 year history of provoking the South Koreans, there is little to indicate that the North intends to escalate matters further. The strategic calculus implies that tensions will fade simply because both sides have so much to lose. A war of words has become far more likely than a shooting war.
Accordingly, it seems likely that some of the risk discount that has been priced into the Asian currencies will begin to disappear as the situation normalizes. The Korean won is supported by a strong export sector and has the potential to gain as investors become less cautious in the weeks ahead. The US dollar, which has been the primary beneficiary of safe haven buying, is already seeing losses against the Asian currencies. The Japanese yen, which has not seen the typical flight to safety inflows due to geographical proximity, has room to rise slightly.
US Growth Promising for Canada
As we often highlight in our presentations, commodities account for a far smaller share of the Canadian economy than is commonly assumed, with exports of other goods and services into the United States having a huge impact on Canadian livelihoods and economic outcomes.
Due for release tomorrow morning, third quarter GDP numbers for Canada are expected to show that growth slowed to an annualised 1.4%, contrasting sharply with a 2.5% gain in the United States over the same period. Rising commodity prices have failed to offset a gaping trade deficit, which is sitting at nearly 4% of GDP – the highest in nearly two decades, and far higher than the US equivalent.
A string of favourable data releases in the US over the past two weeks outlined a steady improvement in spending and confidence levels, raising hopes that Canadian goods and services exports will soon feel the boost. Initial jobless claims dropped, consumer spending rose, and the University of Michigan consumer sentiment index was better than forecast. Tiffany's, the retail spending bellwether reported earnings that were well above expectations. Early reports are suggesting that Black Friday spending in the United States saw a 6.4% increase over last year.
Improving demand in the United States bodes well for the Canadian economy in the months ahead, and should ease the transition from the credit-fuelled domestic growth of the last two years back towards our traditional reliance on exports.
At the same time, with investment prospects improving in the US, Canadian assets are losing some of their alternative appeal, meaning that downward pressure is being exerted on the Canadian dollar. All other things being equal, this is a fairly ideal recipe for sustainable growth, so we may be looking at a healthier Christmas than expected. Have a great week!
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