US Tax Agreement Boosts Global Risk Appetite
- US Dollar Falls, World Markets Rise
- Loonie in Neutral After Bank of Canada Holds Rates
- Tax Deal Expected To Boost US Economy
- Euro Rises on Irish Vote
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US Dollar Falls, World Markets Rise
The US dollar fell and risk assets rose over the trading cycle after President Obama agreed to a tentative deal which would extend Bush-era tax cuts for upper income Americans. The one month crude oil contract broke the $90 barrier, three month copper rose to a record $8,988.25 per metric ton, and gold spiked to $1,428.70 an ounce.
The euro gained slightly on optimism that Ireland will pass an austerity budget today, which must be passed in order to accept the €85 billion dollar rescue package put together by the European Union and the International Monetary Fund.
Loonie in Neutral After Bank of Canada Holds Rates
The Canadian dollar remained in stasis, slightly weaker than par after the Bank of Canada announced that it would hold its benchmark interest rate at 1 percent, for the fourth time this year. In the accompanying statement, the Bank highlighted domestic fundamentals and external risks as reasons for keeping monetary policy relatively accommodative.
The statement said "In the third quarter, household spending was stronger than the Bank had anticipated and growth in business investment was robust. However, net exports were weaker than projected and continued to exert a significant drag on growth. This underlines a previously-identified risk that a combination of disappointing productivity performance and persistent strength in the Canadian dollar could dampen the expected recovery of net exports".
With regard to the global economy, the Bank affirmed its belief that the recovery is progressing, speeding up in the United States, while "growth in emerging-market economies has begun to ease to a more sustainable, but still robust, pace". Carney and Company also observed the fact that "increased risk that sovereign debt concerns in several countries could trigger renewed strains in global financial markets".
Tax Deal Expected To Boost US Economy
The deal announced by President Obama last night is a significant compromise between diametrically opposed policy objectives. President Obama's decision to come to terms with a Republican dominated Congress implies that gridlock may not hobble the political process as much as had been feared.
The compromise will extend benefits for the long term unemployed for another thirteen months, reduce payroll taxes, and the alternative minimum tax will be adjusted so that fewer households will be required to pay. According to the prevailing economic theory, these measures should put more money into the economy, more effectively than government directed spending programmes, because individuals are much more likely to spend the additional income.
More worrisome is the fact that this package will cost close to $900 billion over the next two years, and will be financed entirely by adding to the national debt. This is effectively larger than the $800 billion dollar stimulus package announced early in the Obama administration, and is a strong sign that both parties remain focussed on achieving short term gains at the expense of long term fiscal health.
Euro Rises on Irish Vote
Politically weakened Irish Prime Minister Brian Cowen will go to Parliament today to seek approval for an extraordinarily harsh austerity budget imposed by the European Union and the International Monetary Fund. The measures are considered likely to pass after independent lawmakers indicated that they would support it, but the vote will be fairly tight.
A sense that the immediate crisis has passed supported the euro over the trading cycle, pushing it up towards the 1.34 mark against the US dollar. Spanish and Italian bond yields have continued to rise however, indicating that the move up may be short-lived.
German Chancellor Angela Merkel moved to kill speculation about an increase in the European rescue facility, saying "I see no need to expand the fund right now". This is in spite of the growing belief that the facility isn't large enough to bail out a country the size of Spain in the event that the bond markets force it into crisis. Merkel is in a tight spot politically. Spending more to support the fiscally profligate peripheral economies is almost universally opposed domestically, but she is also aware that such measures may well head off a much more costly crisis in the near future.
The concept of commonly issued euro-zone bonds was floated at the weekend, but already appears dead in the water. Enforcing collective liability on all European countries for individually spendthrift governments is not a popular idea among voters, and courts in several nations have already suggested that this framework would face constitutional challenges.
The Germans have repeatedly suggested that bondholders be forced to accept the possible consequences of their lending decisions after 2013. Given the possibility of loss, the markets would then price higher risks in the weaker economies into bond yields, effectively forcing them to improve public finances over time. This would help to cure what is often known as "moral hazard", when lenders behave differently because they feel that they are insured against loss by larger institutions. Moral hazard has led to some of the largest financial disasters in history, including the subprime crash in the United States, and the current European predicament is no different.
The question over the next year will be whether the common currency area can limp to this logical conclusion - or whether the markets will force the euro to the breaking point long before then.
Happy trading.
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