It’s no longer the pain in Spain after events on financial markets overnight. Fear levels jumped sharply as bond yields in Spain hit new lows, those in Italy rose to six-month highs, the euro fell, then recovered, oil, copper and other commodities dropped and yields in the US, UK and Germany fell to record lows.
Sharemarkets dropped sharply in Europe and the US, which will spark another round of selling in Asia today. The Aussie dollar fell below $US1.03, dropping about one and a half cents in the day. It was a day when investors threw the switch to fear and loathing and abandoned so-called “risk-on investments” such as the Aussie dollar, shares and commodities like oil and even gold.
Not helping sentiment at the end of a difficult day was the news that Moody’s revised to negative from stable the outlooks on the AAA sovereign ratings of Germany, the Netherlands and Luxembourg. (It reaffirmed Finland’s AAA rating and stable outlook). Moody’s also raised the prospect that AAA-rated France and Austria could be downgraded at the end of September if the eurozone crisis continues to deepen and show no signs of resolution. That will rattle markets and clip the glimmer of positive news from a late bounce on Wall Street.
The record lows in bond markets in the US, Germany and UK (and to a lesser extent in Australia, Canada and even France) are telling us that investors are worried about the chances of an economic “disaster”, such as a sharp fall in economic growth in Europe and the US, the fracturing of the euro and that, as a result, these investors are chasing protection at a time when normal investment theory would have had German and US bond prices falling and yields rising (because of weak growth, the loss of its AAA rating and the approaching fiscal cliff in the US, and the fact that Germany is at the heart of the eurozone’s woes and would be badly damaged should a disaster occur).
It is this sort of thinking that has seen an escalation of concern across the board since late last week as investors and commentators started wondering if European leaders have again lost control of the euro crisis. In some respects the events of the past few days, but especially from Friday of last week, are something of a rerun of last September-November when the crisis spiralled out of control as Greece, then Italy and Spain emerged as major concerns. The situation seems to be more fraught than in May and early June as the two Greek elections set off tremors that were settled by the results of the second poll.
That concern was shown by the move by Europe’s main clearing house for settling bond trades, LCH.Clearnet, which raised the margin, or extra deposit, it requires from clients to hold some Spanish and Italian government debt — adding extra pressure to those bond markets and reducing the ability of both countries to sell debt.
Driving the latest fears were a collection of reports late last week and overnight that the Italian province of Sicily was in trouble and might need a bailout from Rome, in the next few weeks. Then from Spain we had reports that the provinces of Valencia and then Murcia and Catalonia (as big as Portugal’s economy) might need financial help from the central government. A German media report appeared on Sunday suggesting that the IMF might stop lending to Greece because it wasn’t doing the right thing.
That was a very provocative report and came on top of growing doubts that the German political, legal and business establishment were going cold on the idea of using the European stability mechanism to be used to inject up to €100 billion into Spain’s banks. The IMF said it was committed to working with Greece and later tonight, a group from it, the EU and European Central Bank arrive in Athens for talks. Don’t hold your breaths for any breakthroughs.
Like late last year, there seems to be no circuit breaker in sight, other than another example of decisive action from the European Central Bank. Its move to offer three-year finance last November settled markets and the second round of funding at the end of last February topped off the pot. But that didn’t last past the end of March as new fears about Greece and Spain emerged. The relative calm after the second Greek poll vanished after a couple of weeks as Spain reappeared to haunt markets and the €100 million of aid for a Spanish bank bailout came and went without settling frazzled markets and nervy investors.
Now there’s another round of selling appearing. First in the Italian market yesterday with the shares of several major banks suspended after falls of 4% or more in a few minutes. That then saw Italy introduce a ban on short selling in financial stocks for a week. A few hours later the Spanish markets regulator banned all short selling for three months after the sharemarket sank to a nine-year low in early trading after a loss of 5.5%. It ended the day down 1% as speculators covered their short positions and forced prices and the index higher. The pan-European market index, the Stock 600 fell 2.5% overnight, almost double the 1.4% on Friday. Bank stocks across Europe and the US, plus America, fell by 1-6% in some cases, meaning the shares of our banks will be sold off today as well.
If what we saw overnight and yesterday continues for the rest of this week without any intervention, there’s a higher chance the US Fed will reveal a third round of quantitative easing at the end of its two-day meeting next week, or soon after. That could be underlined by the first estimate this Friday of US second-quarter economic growth. Market consensus for growth of about 1.3% (annual), down from 1.5 last week and the 1.9% first quarter growth rate. Growth about 1.3% annual for the US economy is close to stalling speed and might force the Fed’s hand, especially if the euro crisis continues at its present disrupting pace.
And more pressure from Europe next week could see the Reserve Bank board seriously consider a rate cut at its August meeting in a fortnight, just as it cut rates last November and December when the euro crisis looked headed for the cliff. At the moment the RBA is seen as not moving on rates, even after what is forecast to be a very low inflation figure for the June quarter tomorrow (with the RBA’s own core measures falling under 2%, the bottom of its 2-3% inflation range.