Friday, September 23, 2011

Sheer unadulterated panic, and self-fulfilling - Adam Carr

"It was just sheer and unadulterated panic overnight. The fallout from the FOMC meeting continued and global markets were smashed. Barely a day or two into things and operation twist has already wreaked havoc on the globe (although stronger USD is good). The fear now, following the Fed’s increasingly desperate and useless actions - is that there is nothing left to stave off global recession.

Now at the moment we are not seeing any evidence of global recession. Growth by and large remains healthy although clearly, with the Fed just doing what it does, European politicians dithering and the constant media bombardment about crises and problems, many of which don’t even exist- the risks have risen markedly. The ‘crisis’ – pick one - has developed its own momentum, it is becoming a self-fulfilling prophecy, which of course makes it much more difficult to deliver solutions.

The impact of this has been most marked on the sentiment indicators so far, as we already know. So it is no surprise, with everything going on, that the European PMIs weakened again in September according to data released overnight. This is turn just exacerbated existing fears about global growth and weighed on markets. The manufacturing PMI fell to 48.4 from 49 which is the weakest result since August 2009 (average 51.5), while the services PMI fell to 49.1, the lowest since July 2009 (average 52.9). It’s clear then that we’ve entered into what’s known circularity, a downward spiral of self fulfilling fear, feeding on fear. And it’s very difficult to see a catalyst for change.

European equities were smashed as the Dax fell almost 5%, the FTSE was off 4.7% and the CaC was down 5.25%. In the US it wasn’t much better as the S&P500 fell 3.2%, the Dow fell 391pts (10733) and the Nasdaq fell 3.25% (2455) – SPI was down 1.9% (3890). The carnage was everywhere and every sector was hit, but basic materials (-6.2%), energy (-5.03%) and industrials were hardest hit.

Commodities, were absolutely #%a& on. Gold lost $34 to sit at $1738, silver fell 11.6%, copper was down 7.3% and softs were off almost 4%. Crude too saw some big moves with WTI off 6.4% ($80.4) and Brent off 4.4% to $105.5. A strong USD, the only positive from operation twist, is a key driver here as we’ve seen the Dollar spike 2.1% so far (0.8% last night). AUD then lost another 250pips to sit at 0.9748 (lowest since March 2011), euro was down 93pips to 1.3462, Sterling lost 114pips to sit at 1.5349, while JPY was down to 76.22 from 76.51.

The main implication of the weaker AUD is that it should gag those harping on about rate cuts here. These people had been arguing that the high AUD was hampering growth, restraining it and contributing to tighter financial conditions. For consistency then, the weaker dollar must, on their own arguments, reduce the need for the RBA to cut. Will be interesting to see what happens on that front. As I noted yesterday this at the least should be a period when our exporters are hedging aggressively. If the AUD goes lower still, then happy days, but if it goes higher, there is no excuse for whinging.

In a general sense where we go from here depends largely on the Europeans now. They could end this at any time if they choose and there is a lot of pressure for them to do so soon – leaders from 7 nations including Australia writing to the G20 asking for action. I’d note though (as I did last year) that for all the vacuous discussion about Greece defaulting - orderly or not - it is actually the most costly option, it is the worst option. Europe has already lost about €200bn in economic activity thanks to the ‘crisis’ (which compares to Greek debt of about €350bn) and it is obvious that the subsequent loss of economic activity (should Greece default), contagion, recapitalisations and costs of building a ‘firewall’ more generally (under the orderly default option), far outweigh any bailout. It’s basic math.

Yet supposedly intelligent people harp on about it as if it were the best or only option. The slogan is – ‘It’s inevitable’. Unbelievably, those who spruik this slogan refer to the Argentinean experience as a major default success story. Yet Argentina’s default didn’t change the need for austerity, it didn’t prevent the pain and in fact made it worse. Years after Argentina defaulted, the unemployment rate was still at 20%, youth unemployment much higher, and, a decade later, they have not been able to tap international debt markets. The scars run deep and for Greece it would be much worse. It is delusional to think of an ‘orderly default’ as a good option for Greece or Europe. On any, even rudimentary cost-benefit analysis, it doesn’t stack up."