Endless Waiting for Uncertainty to Lift

August 17, 2012

Uncertainty continues to be one of the most frequently heard financial market buzzwords.  The term encompasses the reality that many pertinent pieces of influential information cannot be guesstimated accurately.  Investors end up sitting on the sidelines, waiting in vain for some clarification that never comes.  Consensus expectations aren’t necessarily frozen, but opinions are held with less conviction than in times of less perceived uncertainty.  Three areas of greatest uncertainty at the moment concern

  • Whether the conditions for an EU bailout fund involving ECB participation are met and whether such permits a sustained reduction of regional financial market distress,
  • How the uncertain outcome of U.S. presidential and congressional elections on November 6 affects fiscal policy in 2013 and the longer run, and
  • The near-term response of major central banks to this year’s slowdown in global demand and output.

In these continuing dog days of August, hope has spiked that each of these broad unknowns will become clearer during the rest of 2012, and that has permitted some guarded optimism to enter the collective psyche of investors.  Equities in most markets have climbed this month.  Many peripheral bonds have enjoyed a respite. For example, the 10-year Spanish sovereign debt yield of 6.48% is 80 basis point lower than its July 20th peak.  Commodity prices are no longer falling.  West Texas Intermediate oil prices have rebounded over 20% from their June low.  Safe-haven currencies like the dollar and yen still show net advances since the Memorial Day weekend but have relinquished some of the gains this month.  After falling moderately earlier in the summer, the Chinese yuan has likewise stabilized.  Commodity-sensitive currencies were the biggest winners in June-July, benefiting it would seem from diversification of Switzerland’s rapidly ballooning stock of currency reserves.  In a further sign of a shifting mood, however, the greenback has advanced 1.4% and 0.7% this past week against the Australian and New Zealand dollars.  The loonie, in contrast, has pushed 0.3% further upward.

A momentous month lies ahead for Europe.  ECB Pdt Draghi speaks at the Jackson Hole Symposium on September 1, five days before his post ECB-meeting press conference at which new staff macroeconomic forecasts will be unveiled.  In September, moreover, there will be multiple meetings of EU finance ministers and leaders, a German court ruling on the constitutionality of proposals that would permit a collective EUR bailout facility, and a likely negative assessment by Athens’ creditors of Greek compliance with promised reforms.  Nothing substantial has occurred thus far beyond various verbal assurances from officials to preserve the common currency, and the potential remains for an abrupt and substantial deterioration of European financial markets.  It’s also possible that ways will be found to prolong uncertainty without tipping the evenly balanced pendulum between resolution and no resolution.

At stake in a closely fought U.S. election are two broadly different visions of the size of government and preferred brand of capitalism.  The coming three weeks include the Republican Convention in Tampa on August 27-30 and Democratic Party convention in Charlotte on September 3-6.  This will be followed by two more months of campaigning with three heavyweight debates, Election Day on November 6, and 9-1/2 remaining weeks of 2012 in which a lame duck congress will attempt to lessen the severity of the fiscal cliff that looms in January.  It’s been said that the vision of Romney and Ryan seeks to turn back the clock to pre-New Deal America, but the time travel would really be closer to a century, taking back some of Teddy Roosevelt’s Progressive Movement accomplishments too.  With an appeal for voter patience and a message that the devil you know is better than the one you don’t know, Obama and Biden offer some moderate income redistribution, which would unwind only part of changes that occurred over the past two decades.  Opinion polls indicate that almost all U.S. voters have made up their mind and reflect an extremely polarized and angrily divisive populous that is more likely to become even more toxic next yearFiscal certainty in 2013 will remain elusive.

I believe markets are more likely to be a little disappointed by the degree of new monetary policy support in the coming month than in awe of big bazooka stimulus.  Draghi’s address at Jackson Hole comes a day after the even more anticipated speech there by Fed Chairman Bernanke.  Because of several better-than-expected U.S. economic news this month, speculation has lessened that Mr. B will use the opportunity as he did two years ago to preannounce some quantitative easing.  Even before this month, I doubted the FOMC would ease policy at its September 13 meeting, given the nearness to the election, a split of sympathy among Fed officials for the usefulness and appropriateness of quantitative easing, and the fact that the Fed did not cut interest rates at its September 2008 meeting when economic trends were much darker than now.  In Europe, meanwhile, recent Bank of England minutes suggest a lesser predisposition to stimulate than markets were expecting, and it also seems plausible that the ECB will not provide as forceful support (with inflation stuck at 2.4%) as some are hoping.  As for China, the third main pillar of central bank watching these days, it is probably already too late for any action that would change prospects through mid-2013 in a dramatic way. 

The week to August 24 is lighter than the final week of August from the standpoint of scheduled data releases both quantitatively and qualitatively.  Baring the unexpected geopolitical or domestic political bombshell, policy matters are likely to stay on simmer rather than boil over.  It’s tempting to conclude that next week will not be especially eventful in foreign exchange. 

  • EUR/USD has stabilized, and technicians are citing 1.2350 as a demarcation between holding steady and perhaps challenging the 1.24 level.  As has been so for several weeks already, EUR/USD will be captive to what is happening in the euro’s major cross relationships. 
  • Swiss officials show no sign of abandoning intervention to enforce their franc ceiling of 1.2000 per euro.  The market, for that matter, hasn’t stopped speculating on an eventual upside breakout.
  • Just call it “stable cable”, cable being the relationship between the dollar and sterling and stable being the pair’s amazingly flat trend since Memorial Day.  If it was in the cards for an Olympic hangover to break up this stalemate, it should have happened this past week rather than next week.  Instead, all that one saw were some press stories that a weakened government coalition and persistent double helping of recession in Britain makes the pound look increasingly vulnerable. 
  • Dollar/yen had also been a boring relationship until a 1.5% dollar appreciation this past week.  Officials in the DPJ government continue to jawbone the currency lower and clearly would prefer 85 per dollar or softer.  Lower house elections seem likely this autumn, and a shift in ruling party is plausible.  LDP leaders also would be delighted if the yen were to soften.  Japan posted 3.4% annualized growth between 4Q11 and 2Q12, but much tougher sledding lies ahead.  The politicians may get their wish for a somewhat weaker yen.
  • Commodity-sensitive currencies had performed better than commodity developments would seems to warrant.  Normally, this disparity would suggest caution before jumping on the bandwagon, but the strength of this currency bloc may actually have a less random basis.  It is believed to reflect diversification by the Swiss National Bank of its rapidly expanding currency portfolio.
  • The yuan has retreated from readings six months ago of marginally below 6.30 per dollar.  No movement of the yuan — daily, monthly or quarterly — happens without the consent and orchestration of officials.  Any decline over a span as long as a half year is noteworthy because of the lack of recent precedent since the 8.277 per dollar peg was removed just over seven years ago.  Tough language about Beijing will be heard during the U.S. presidential campaign because that always happens in the heat of the campaign.  This time, however, China is engulfed in a political power transition of its own, and the complaints of foreigners will play second fiddle to concerns about slowing demand for Chinese exports.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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