Contagion Fears Grip Currency Markets
- Debt Dominos Continue to Topple
- Commodities Rally, Commodity Currencies Flounder
- Canadian Dollar Plummets on Negative GDP Report
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Debt Dominos Continue to Topple
In a clear repudiation of the European Union's rescue attempts, stress in the common currency area rose to new heights over the last trading cycle. Yield differentials between Portuguese and Spanish government bonds and German skyrocketed to heights not seen since the zone was formed, and the euro fell almost 2% against the dollar as investors deserted the debt markets in droves. The unified currency briefly slid below 1.30, notching up a 6.5% drop for the month so far.
President Clinton's political adviser James Carville said; "I used to think that if there was reincarnation, I wanted to come back as the President, or the Pope, or as a .400 baseball hitter. But now, I would like to come back as the bond market. You can intimidate everybody". Indeed, governments, banks, and investors are all running scared as the debt markets descend into dysfunction.
Spanish and Portuguese debt instruments are now trading at premiums last seen before they entered the European Union. Yesterday's Italian debt auction saw yields rise almost 10% from a month earlier. To put this into perspective, Spain's economy is almost two times larger than the combined economies of Greece, Ireland and Portugal. Italy's is one and a half times larger than Spain's. The fact that investors are seriously questioning the creditworthiness of these countries represents an immense challenge for an economic area that represents almost 20% of world GDP.
In essence, the Greek and Irish bailouts have laid bare the weaknesses inherent in the loose political structure that governs the European Union. At each juncture in the crisis, political imperatives have trumped financial exigencies, allowing problems to grow without resolution. Unless the European authorities manage to change this dynamic by pulling a rabbit out of a hat, there are very few market participants who would place bullish positions on the euro, meaning that there appears to be little stopping the currency from moving well below the 1.30 mark against the US dollar.
Commodities Rally, Commodity Currencies Flounder
Front month crude prices rallied almost three percent on speculation that strong Black Friday spending numbers and the solid consumer sentiment indicators reported last week would feed into higher fuel demand. With a colder than normal winter expected, heating oil usage is forecast to increase. Inventories are also slumping, causing some to call for $100 oil again in the short term. Given the elegant simplicity of this number, a momentum trade cannot be ruled out in the coming months, although fundamentals would not support prices at such levels for long.
Gold prices also rose as the precious metals complex saw inflows from investors seeking safe havens. Base metals such as copper and zinc had a volatile session, with concerns about supply shortages pushing prices up, while worries about the long term effect of Chinese tightening measures capped rallies. Copper gained 1.3% and zinc was up 1.9% at the time of writing.
The Australian and Kiwi units failed to capitalize on commodity price strength, with both currencies seeing outflows as global risk aversion combined with deteriorating domestic fundamentals to hurt sentiment. Australia's growth has been slowing quickly as global inventory restocking has run its course, with GDP expected to drop to 0.4% over the last quarter versus 1.2% in the previous three months. New Zealand has been experiencing significant headwinds as external demand stagnates and the housing market slows. According to a report published yesterday, home construction has fallen to levels last seen in July 2009. Both currencies have lost more than 2% this month, with daily price movements that are highly correlated with the ongoing downward slide in Chinese equity markets.
Canadian Dollar Plummets on Negative GDP Report
The Canadian dollar fell sharply this morning after Statistics Canada reported that third quarter growth slowed to an annualized 1% rate, well below market expectations. The economy actually contracted 0.1% during September, as exports fell and the construction industry contracted.
According to figures released yesterday, Canada's trade deficit widened to a record $17.5 billion in the third quarter with exports declining by $680 million and imports surging to almost $3.59 billion.
After experiencing the benefits of an unprecedented expansion in credit and one of the world's largest stimulus packages over the last years, the Canadian economy is running into headwinds as government programmes end and consumer spending slows.
Finance Minister Jim Flaherty recently announced that the government's two year stimulus spending package would be wound down at the end of March, leaving the economy to stand on its own. According to the Bank of Canada, citizens have collectively run a net financial deficit for 37 successive quarters, with investment in housing outstripping total savings for nine straight years and creating the conditions for a significant slowdown in consumer spending. Growth will have to come from exports.
Canada's relatively stable fiscal position should continue to drive safe haven flows, particularly while the credit crisis in Europe rages, but the fundamental argument for longer term weakness is certainly growing stronger. Of course, the upside to the downside is that exporters could certainly use the boost!
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