Fed Disappoints, and Risk Assets Get Sold

Good day. The FOMC meeting minutes were the cat’s meow for the markets yesterday, and boy, did they come away feeling as if someone just stole their puppy! Once again, the Fed has disappointed the markets, which, for some reason, thought for sure the FOMC meeting minutes would give them reason to believe that more stimulus was coming. I tried to warn them; if they had only read yesterday’s Pfennig, they would have known that Chuck said the meeting minutes were stale, for they took place a full week ahead of the jobs jamboree disappointment.

But acting as if they were just left at the altar, the markets took their fury out on the risk assets, and they took no prisoners. The euro (EUR) lost ground, the Australian dollar (AUD) lost over a cent and gold lost another $10. I just don’t get these trader guys (and gals). What the heck do they want?

I know what they want, but do they “really” want that? They think they want more stimulus, that the market can’t function without it. But in reality, they want to be right —  they want to be able to say, “See, I called this stimulus, and I was right!” Never mind the damage that the stimulus actually does to the country’s balance sheet.

I was sitting at the desk yesterday, watching the euro losing footing it had gained overnight once again, and began to think about what I had said at the start of this year: “I wouldn’t be surprised to see the euro fall to 1.18, or rise to 1.40 this year.” I think the first part of that thought is about to come true, folks. Here’s why I think that way.

Remember the eurozone summit, which took place a couple of weeks ago? The eurozone leaders surprised the markets by actually coming up with a plan, and a new suggestion to use the ESM (European Stability Mechanism) for recapitalizing the troubled Spanish banks. And the euro found some terra firma, but not much, and soon that gained ground was lost.

Now it’s been two weeks since the meeting, and nothing really has come of it. Now we learned the other day that 12,000 complaints have been filed in the German Constitutional Court (GCC) against using the ESM that way. It’s going to take the GCC most of the summer to get through everything and make their decision. That’s just too long for the markets, folks.

In addition, summer is normally a slower time in the markets, especially in August, when most of Europe goes on holiday (vacation). The exception to that was last summer, when the U.S. debt ceiling debacle unfolded, giving everyone in the markets the willies toward the U.S. dollar.

Now — when a few months ago, I thought that the U.S. election campaign would focus on the debt, and the debt ceiling issue will be revisited in August or September again — the euro would be saved, for the moment, from revisiting 2005 levels of 1.18. But, from what I’m watching on TV, the election campaign is going to focus on jobs, so out the window goes the knight on the white horse for the euro this summer.

I’ve gone on pretty long here with regards to the euro, but since it is the offset to the dollar, it’s important, folks. But there you have it — Chuck’s thoughts on the euro for this summer.

And since I’m in such a dour mood on the euro this morning, I might as well get this out there too. Yesterday, I mentioned that someone sent me a note about the Aussie dollar (A$) being overvalued. I’m reading more and more research reports calling for the A$ to get downsized as China bottoms out and struggles to regain their economic prowess.

They all make sense to me, except what if China takes the bull by the horns and really turns their economy around, as they did in 2008? Of course, that will take three or more months to confirm, so until then, we could be looking at cheaper levels to buy A$s. So as an A$ holder, you could very well take profits and look to buy cheaper, or just batten down the hatches.

Why does it feel as though the dog days of summer for the currencies and metals are right here, right now? Because that’s what’s happening! I wish I could tell you something different than this, but as I say all the time, “it is what it is.”

This morning, eurozone industrial production printed for May and showed an increase of 0.6% versus April, with Germany providing the cushion for all the countries posting negative numbers. And while May’s number is good, it’s May’s number —  that’s right, it’s two months old! I just don’t get why it takes so long for data to print! The other problem with the number is we could average out April and May’s IP, and it would still be 0.9% below production levels of the first quarter. So the slowdown in the eurozone continues to extend its roots.

And the forecasters in Australia were right for once, as they had forecast no job growth for Australia in June, and in fact it was negative, with June’s job losses wiping out May’s job gains. This was much weaker than expected or forecast, and it weighed heavily on the A$ as the night went along. It’s almost like a perfect storm for the A$, because now it will have to deal with the China second-quarter GDP report that will print tomorrow. I’ve already told you how it is widely expected that China’s second-quarter GDP will be very weak. But again, let me go through this for those of you who missed class yesterday. All those that attended can skip to the next paragraph — that is, unless you need a review.

OK, the Chinese economy probably bottomed in the second quarter, which means this GDP report is going to be ugly, folks, and the knee-jerk reaction to sell the A$ will be strong. But everyone needs to calm down here. As I said above, the GDP report is old, and if the Chinese economy actually is rebounding in the third quarter, then what good is it to sell Aussie dollars now, on an old report?

All right, I’ve spent quite a bit of time on the euro and A$ this morning. And China! What about the other guys? Let’s see… the Japanese yen (JPY) is a bit stronger this morning, nothing to write home about, and the rest are following the euro and A$ down the road to the woodshed.

The Bank of Japan (BOJ) also disappointed the Japanese market watchers by holding back on more stimulus. So it’s the season of disappointment for the markets. I have to say that I’m somewhat impressed that the central banks, mostly the Fed, have held back on their feeling that the economy can be saved with stimulus. But they will revert to that feeling soon, folks, so don’t go giving Big Ben Bernanke any gold stars now.

Speaking of Big Ben, yesterday, the FOMC meeting minutes noted that a “few members were for adding more stimulus.” I said to the boys and girls on the trading desk that “all of the members could feel that way, but unless Big Ben feels that way, no stimulus will be implemented.” Yes, this Fed is run just like Big Al Greenspan’s Fed. It’s pretty much like here on the trading desk. I remind the people here, from time to time, that this is a benevolent dictatorship, and I can remove the benevolence at any time! HA!

The third California city has filed for bankruptcy and is seeking protection. San Bernardino was the latest to file. And why isn’t this big news? I’ve pointed to California’s debt problems for over two years, and still everyone is fixated on Greece. The problems for San Bernardino aren’t just confined to payroll, benefits and pensions. Nearly half of the homeowners in the city, who own more on their mortgages than their homes are worth, are increasing the risk that they will default on their loans.

But it’s all about Greece or Spain or whomever, right? The last time I checked, California was the eighth-largest economy in the WORLD! I don’t think you would see Greece in the top 100. But just like things in Greece, things in California aren’t a problem, until they are a problem — sound likes a Yogi-ism, but it’s true. One day, investors and traders decided that things weren’t good in Greece, which for years was able to issue debt at the same yields as Germany, and then one day they couldn’t. It will be the same for the U.S., and to further this discussion, just wait until the government gets their hands into the California foreclosure problem and acts as if they know what they are doing.

Then There Was This… Federal Reserve Bank of St. Louis President James Bullard said the U.S. fiscal position is as weak as some euro-area countries,’ and lawmakers must take “dramatic” measures to tackle it and restore confidence.

“The U.S. fiscal situation is similar to that of some countries in Europe and requires dramatic and sustained attention,” Bullard said in a speech in London. “The political compromise in the U.S. has been to delay action until after the November election, but markets tend to pull the uncertainty forward.”

Chuck again. Bullard went on to say something that I thought I would never hear from a Fed head. Let’s listen in:

“Increased government spending today, followed by higher future taxes, is not likely to produce more rapid growth. The most-likely way forward continues to be a long period of debt paydown and sluggish growth, both in Europe and the U.S., and that the most-pressing policy issue is to accept this path and prevent any additional problems from developing.”

Are you kidding me? Did a Fed head actually say a long period of debt paydown and sluggish growth? Why, yes, Chuck, he did! James Bullard gets a gold star!

To recap… The FOMC meeting minutes, although they were stale, disappointed the markets, and the markets took their fury out on the risk assets. The euro has fallen below 1.22 for the first time in some time, and Chuck gives us his dour outlook for the euro this summer. Eurozone industrial production was strong in May, but not as strong as the month reports from earlier in the year, thus confirming the economic slowdown of the eurozone. June job losses in Australia wiped out job gains in May, and the A$ has lost over 1 cent overnight.

Chuck Butler
for The Daily Reckoning

The Daily Reckoning