Forex Market Outlook 12/29/11
Do not go gently in to that good night…. at least that what the markets are saying as we close out 2011. The markets had been trading in a fairly tight range until yesterday, when the US dollar strengthened and the “risk currencies” broke down. The move lower was most heavy in both the British pound and the Euro, which is trading at a 10-year low vs. the Japanese yen.
So what the heck happened? There wasn’t a lot of data-related news yesterday so what gives? Well, there were two pieces of news that the market pounced on, and both were related to the Euro debt crisis, which should be no surprise to anyone at this point.
The first piece of news was about the Italian bond auction yesterday which was initially seen as positive because rates came down, but the markets quickly picked up on the fact that this was short-term debt so it should have been easy to issue. The market quickly moved the focus to today’s Italian debt auction which was for longer-term debt, and the picture, as some may have suspected yesterday, was not as pretty. While the interest rate on the bonds was just below 7%, the bid to cover was not as high as they would have liked to see. Fast forward to January, when the real fun starts as they have a lot more debt to issue than this month and some in the market are concerned that the interest required for longer-term debt is unsustainable.
The second piece of news that largely escaped attention in the early session was the fact that European banks left record deposits at the ECB. While this seemed like an innocuous announcement, the markets read into it that European banks were afraid to hold money for fear of counter-party risk. In other words, they know at the end of the day that they will get their money back from the ECB.
Why is this important? Because this could lead to a funding or liquidity crisis if banks are afraid to lend to one another which could eventually cripple the banking system. This started to occur here in the US in 2008 before then Treasury Secretary Paulson stepped in with the “bazooka”. Does the ECB have such a mechanism? Highly unlikely.
They have announced though that they have expanded their balance sheet greatly and if you recall from my discussion last week, this is basically a form of quantitative easing. However, this may be a knee-jerk reaction as little has really changed other than the fact that many in the market have shut down operations for the year.
The other issue to contend with is that all of the Euro zone austerity that is being enacted to combat budget problems will likely drag the region into recession in the early part of the year. This will make it harder for debt service to take place, especially if yields continue to remain at elevated levels. So it looks like the markets just wanted to get through the holidays, then deal with the issues afterward.
Yesterday’s market sell-off was highlighted by a drop in the price of gold, which has continued into this morning with gold trading down to the $1530s. Oil also traded lower to back under $100 despite the threats coming from Iran about supply disruptions. Stocks also moved lower, but are looking to open slightly higher this morning.
This morning brings initial jobless claims and pending home sales data which on the surface shouldn’t be game-changing figures. Though with jittery markets, you never know what can happen. As long as the jobless claims figures stay in the 300K range, it should be positive.
With huge sell-offs like we saw yesterday, the following day is sometimes a bounce-back as short covering takes place. If today is not a big move back higher, then the downtrend will likely be in tact until after the New Year.
Be cautious in these markets, as the lack of volume can produce out-sized moves when everyone is on the same side of the trade. This can lead to additional volatility, which is good for short-term traders but bad for longer-term investors. I have been favoring the short-term for most of the month, and will continue in that fashion until some clarity emerges.