Inching Toward a Spanish Bailout?

Good day…and welcome to another Wednesday. I’ll start the day off with a note from our fearless leader… Take it away Chuck!

“Hello! It’s good to talk to you all dear readers again! Yes, I’ve been in touch from time to time with Chris, but I was going through the Pfennig email box and saw that Mike was getting asked to say something about my status. So, being of sound mind (my beautiful wife would question that!) but not body. Here goes… Well, this journey began with me waking up in the middle of the night on Labor Day weekend with my left leg swelling and very painful.

“Having experienced two blood clots in that leg in the past 5 years, I immediately thought, oh no! Another blood clot. It got so bad that by morning, we headed to the hospital. Yes, the two blood clots were still there, but no new ones. Instead, was the nastiest infection in the whole lower leg called cellulitis. This was 3 days before my scheduled jaw surgery, so the surgery had to be postponed, for no surgeon would perform surgery with that kind of infection in my body. But, what then happened had to be considered sort of a miracle. I left a week later to see a renal cell specialist at the MD Anderson Cancer Clinic. After reviewing all of my pathology, scans, MRI’s, and so on, they decided that they thought they could save my jaw from being removed! YAHOO!

“So, I’m on a new drug to shrink the tumors in me. Yes, there’s one in my mouth, and one in my chest, and I’ll be monitored here, and return to MD Anderson in two months. So, now it’s all up to the medicine. I’ve been taking it for 5 days now, and on the 7th day, it’s supposed to ‘kick in.’ I truly expect to be back at work next week, but I’ll have to see how I tolerate the medicine. My leg is still very painful, but tolerable, and I still need to keep the infected area above my heart for much of the day, and all night.

“So, there you go! I want to thank all the dear readers for their thoughts and prayers, for I think that’s why the infection showed up 3 days before my surgery! Call me crazy, but it’s what I believe so, I’ll talk to you all next week.”

It’s definitely good to hear from Chuck and its certainly good news that he’s making strides in the right direction. Moving on to the task at hand, residual concern over the European debt crisis remained in control of the markets and it looks as though this trend has sprouted some legs. Until we get something out of Europe or the US that is able to steal the spotlight, investors will most likely keep the focus in place with bond yields at the top of the list. The markets also seem hesitant to move too far in one direction or the other until we see more action by the ECB, but the bandages are currently holding things together.

Spain did have a successful auction of shorter term bills yesterday and ended up selling more than the maximum target, which is exactly what officials want to see, and had the desired effect of lower yields. We’ll see another auction tomorrow, but the all important 10-year yield ended the day at 5.91%. Spanish officials have been going back and forth about seeking a bailout, but it looks like both sides agree that additional austerity measures on top of what’s already in place isn’t exactly the desired course of action. As bad debt in their banking system rose to a record 9.86% in July, it’s looking more likely a bailout would take place at some point but I think we’ll see a lot of negotiating from both sides before that takes place. The problem going forward, however, is that investors could force the issue much sooner if bond vigilantes begin to smell blood.

Focusing on Germany for a moment, we saw domestic investor confidence in September increase for the first time since April, albeit still in negative territory, and is primarily due to the announcement of the bond buying program at the beginning of the month. The fact that the German constitutional court is on board with the rescue also added to sentiment as German stocks were trading near a 1-½ year high. As always, if we drill down a bit, the gauge of current happenings has fallen to a June 2010 low so we’re still looking at a fragile and challenging situation. I saw a projection that’s calling for economic growth to come in at 0.8% this year, which is considerably lower than 3% growth in 2011, but the global environment could knock that figure lower by the time it’s all said and done.

While the market kept the focus on Europe, we did have a couple of economic reports in the US that we’ll talk about. First, the current account deficit, which is the broadest measure of international trade, fell more than expected by coming in at -$117.4 billion. It does mark an improvement from the revised figure of $133.6 billion in the first quarter, but prospects of slower exports have some calling for continued widening of this number. If we look back a couple of weeks, the larger trade gap in July isn’t a good start to the third quarter, as the deficit with the European Union widened to a five-year high. But like I mentioned yesterday, there aren’t too many headlines that follow this report anymore.

The TIC flows, or international purchases of US financial assets, did rise but blew the expectations out of the water as they increased over seven times the original estimate. The net long-term flows amounted to $67 billion in July, much more than the $9.3 billion we saw in June and the $27.5 billion estimate, as investors sought protection from the European financial markets. A testament to this movement can be seen as France gobbled up 32% more Treasuries than previously, but China retains its top spot as the largest foreign owner of US Treasuries with $1.15 trillion in holdings. It looks like this trend should be present when we see the August results as tensions were still elevated.

The last report from yesterday revealed higher confidence among US homebuilders during the month of September. The National Association of Home Builders index rose to 40, which marks the highest level since June 2006. Keep in mind that readings below 50 indicate more pessimism than optimism, but lower real estate prices and interest rates at record lows were enough to tip the scales and has kept things well above the record low reading of 8 back in January 2009. As I mentioned yesterday, it’s going to be an intensive day of housing so we’ll see how enthusiastic buyers really were in August as we see the results of existing home sales.

The Fed is trying to go all-in with the housing market as they aim to keep interest rates at rock bottom levels for as long as possible. While it sounds good in theory, there are still way too many headwinds from having any type of significant impact in the near term. We’ve covered the unintended consequences over the past couple of weeks but lower interest rates aren’t very useful for all of those stuck in upside-down properties or whose credit situation or joblessness is preventing a refinance or purchase. With that said, the experts are calling for a 2% rise in home sales during the month of August.

Moving on to the currency market, it was kind of a mixed bag type of day as most of the currencies traded within a tight range. It was pretty much the US dollar/euro (EUR) story all day long. The euro ended the day in last place with a 0.50% loss and was trading around 1.3045 as I left the office last night. When I said a tight range, the euro was a perfect example as it held firm between 1.3060 and 1.3030 during US trading, so most of its fall occurred before we even had our morning cup of coffee. I already addressed the reasons for its fall, but the Swiss franc (CHF) broke away slightly and finished the day with a fractional loss.

Taking a look at the leader board, the South African rand (ZAR) finished in first place with nearly a 1% gain. You would think with investors walking on eggshells that this isn’t exactly conducive to a higher risk currency such as the rand, but we did see some good news as striking mine workers came to an agreement and headed back to work. Since mining is important to the domestic economy, it was certainly welcome news. The state of the economy still isn’t in the best of shape as consumer confidence remained near a four-year low, but the news from the mining industry was enough to offset. Much like Brazil, the rand is one of the more volatile currencies so not exactly what you would consider a core currency.

The Swedish krona (SEK) finished in second place as policy makers indicated they won’t take active steps to weaken the currency. Investors became a little skittish after the surprise rate cut, but minutes of that meeting uncovered the fact that officials aren’t calling the currency appreciation a remarkable event given the nation’s economic outlook. The central bank governor went on to say the krona is at a level which is stronger than many times before, but it’s not an extraordinary or different krona strength since they have a large current account surplus and sound public finances.

Another currency whose central bank released minutes of the previous policy meeting was Australia. The RBA said currency strength and slowing Chinese growth could pose risks to the economy. The minutes also conveyed investment plans that could substantially increase investment over the next year, so the case can be made to cut rates or leave them on hold at their next meeting. With that said, investors are currently pricing in a 72% chance that interest rates will be cut to 3.25% next month but I think any additional signs that China is continuing to slow would be the final nail.

Investors were also anticipating the results of UK inflation in August, which held steady on an annual basis at 2.5% and was lower than July’s 2.6% figure. As inflation remains above its 2% target, the debate remains as to continue the stimulus program or cut back in an attempt to steer it close toward the comfort zone. While slower economic growth is expected to naturally take inflation lower, the fact its outpacing wage growth by 1% is what makes this a challenging environment. Eyes will be focused on the minutes of September’s policy meeting to get a better understanding on how officials voted with respect to their bond purchases.

There wasn’t really any market moving news from the other major currencies, so I guess we could throw the rest of the field into the peleton. Except for the currencies mentioned above, they all finished plus or minus by a fraction of a point. The Swiss government cut its economic growth forecast this year down to 1% and home prices in China have moderated. The Chinese property market has been a concern since any type of sustained increase most likely would translate into additional tightening measures from the government. Other than that, I saw where some economists are expecting the Singapore government to tighten the pace of its currency appreciation band a little bit since inflation is forecast to slow heading into next year.

Chuck also sent me some thoughts on gold, so here you go. “A chartist friend of mine, sent me a note yesterday, and pointed out that the price of gold’s 55 day moving avg. was getting very close to crossing the 200-day moving average. If this happens, and I believe it will, it could generate a ton of technical buying. I know, it’s not fundamentals, but every now and then I like to mix the fundamentals with the technicals and this is one of those times!” I also came across an opinion from Bank of America where they see gold rising to $2,400 by the end of 2014 if the Fed continues monetary easing over that time frame.

As I came in this morning, there wasn’t much conviction in the markets either way during the overnight trading sessions so things are pretty much right where I left them last night, with the bias pointing toward a stronger dollar at the moment. The euro was able to hold onto the 1.30 handle and the Japanese yen (JPY) showed some weakness as the Bank of Japan joined the ECB and Fed with additional stimulus efforts. Other than that, not much happened overnight, so we’ll see what kind of impact the housing data in the US will have right off the bat this morning.

To recap… Chuck gives us an update and it sounds like things are progressing. Concerns over in Europe were in control once again but Spain did have a successful bond auction which brought about lower yields. Investor confidence increased in September but remained in negative territory. The current account deficit along with the TIC flows in the US both fared better than expected and a gauge of homebuilder confidence increased again. All in all, it was a fairly quiet day in the currency market and the rand held the top spot as miners returned to work. The Swedish government indicated no active intervention measures and Australian policy makers could be kicking around a rate cut.

Mike Meyer
for The Daily Reckoning

The Daily Reckoning