Markets Lighten Up On Europe

Good day…and welcome to another Thursday morning. It’s been a very busy week so it’s nice to finally see light at the end of the tunnel this morning since Friday is right around the corner. A chilly morning actually turned into a wonderful drive home last night. It hasn’t been too often this summer that I’ve been able to roll down the windows without the air conditioner fired up, so it was a nice change of pace. The currency market has changed directions so far this morning but it really hasn’t changed pace at all this week and has been driving on the same tank of gas for the past several days.

With that said, total market emphasis on Europe lightened up a bit yesterday but the same concerns remain present. The Spanish prime minister spoke up and said the government is committed to cutting the budget deficit, which helped the yield situation, and is trying to take a proactive approach in setting the stage for a bailout at some point. He went on to say the policy is to reduce the deficit because if they don’t, it won’t be possible to finance themselves internally. We’ll see the results of the 10-year auction today, and all indications point toward a success since the yield environment has improved over the past couple of weeks.

The market has reevaluated its fundamental view of the euro zone so all of the peripheral countries are looked upon in the same light, which makes things even more complicated. For example, if Spain gets some type of plan put together and begins down the path of the straight and narrow, it’s possible that Greece or another country that takes a stumble could overshadow those efforts. In other words, they are all considered one entity so any flare up in one country would most likely translate to a rise in yields for all. It’s kind of like the movement of the euro (EUR) setting the tone for the movement of the Norwegian krone (NOK) in that individual fundamentals aren’t exactly paramount.

We also saw euro zone construction output fall in July for a second straight month led by reductions in Italy and Spain, which fell 2.2% and 2.1% respectively. Output in Germany was the one bright spot as it increased 1.9% from June, but that still doesn’t offset the economic slowdown that’s expected to surface in the 3rd and 4th quarters. The money market seems to be holding steady at this point as the measure of banks’ anxiety to lend amongst themselves remains at the lowest figure in 16 months.

Moving on to the US data wagon, we saw a host of housing indicators that had many jumping for joy. First we had the inconsequential measure of mortgage applications from last week and yielded a drop off from the previous week. I don’t think this came as any surprise since the 10-year Treasury saw a nice little bump in that span of time. I guess I’ll kick off the more substantial data with the results of August housing starts.

We did see new construction in August increase as builders broke ground at an annual pace of 750K, but it was a bit lower than the original estimate of 767K. This did mark an increase over the July results, but that figure was revised down to 733K and represented a 13K reduction from the initial result. I’m not sure if this is the beginning of a new trend, but ground breaking on multifamily homes fell 4.9% while construction on single family homes rose 5.5%. In the past, builders were scrambling around to begin building apartments as the rental market was heating up, but this sector might be losing steam as lease payments continue rising.

Nonetheless, higher optimism via the home builders index looks to be warranted with this result. The most telling report, which was existing home sales, did manage to hit a two-year high as they came in at a 4.82 million annual clip. The initial projection was 4.52 million so the August result far exceeded expectations and represented a 7.8% increase from July. If we take a look at the year-over-year rise, sales increased 11%. To put things into perspective, this report saw its low of 3.39 million in July 2010 and its high of 7.25 million in September 2005, so it has definitely moved in the right direction.

Furthermore, the group that keeps track of all this stuff indicates a normal market is defined by a sales pace of between 5 to 5.5 million. Not that you want to see all of the moving pieces here, but I at least find that kind of data interesting. Cash transactions accounted for about 27% of the purchases, which is well above the norm, so nearly a third of the sales didn’t involve a lender. We also saw distressed sales account for roughly 22% of sales and was the lowest percentage on record. Keep in mind they just started keeping track of this four years ago, but it’s still an improvement.

The last piece of housing data came in the way of building permits, which are forward looking and used by some to tell the future. The August report was a mixed bag as the report came in higher than expected but lower than July’s result. As the Fed continues to preach how low rates are going to create jobs, I found a statistic that’s kind of related. The number of employees in the homebuilding industry maxed out at 1.02 million back in 2006 and those currently in the field are about 564K, so that’s pretty close to half of the jobs which were wiped out. In order to see anywhere near those previous highs, the housing market would need to work itself into a frenzy in a hurry to have any type of measurable impact on unemployment in the foreseeable future. I just don’t see that as a likely scenario.

Moving on to the data reports due this morning, we get the weekly menu items of initial jobless claims along with the continuing claims figure. The results from last week weren’t very encouraging as we saw unemployment applications rise to a two-month high of 382K. We’re supposed to see an improvement to 375K today while the number of continuing claims is expected to increase a bit. As we get closer to the holiday season, I would expect to see improvement in these numbers as many retailers seek interim help. It’s always tough to get a true sense of direction when the market is flooded with part time help.

We also see a preliminary national manufacturing report along with measures of consumer comfort and expectations. I’m actually interested to see the Philly area manufacturing report since the New York area took quite a hit. I think at the end of the day, we should have a better grasp of what the big manufacturing report could look like. Lastly, we’ll see leading economic indicators from August, which is expected to show a decrease in the economic outlook over the next six months. We don’t have any data released tomorrow, so it was a light week in terms of economic reports in the US.

If we take a look at the currency market, there really wasn’t much to speak of except for a couple of outliers. Most of the currencies, once again, finished with fractional returns so most ended the day at breakeven. The high and the low for the euro had already taken place by the time I fired up the computer screens yesterday and it was trading at the same price at the end of the day compared to when I arrived, which was 1.3050. The equity markets also had a tight trading day, so it doesn’t look like anyone wanted to disturb the waters.

The big news of the day came out of Japan, and consequently, had the best performing currency by appreciating just over 0.5%. The Bank of Japan joined forces with the ECB and the Fed by entering into another round of quantitative easing, so the world’s largest economies are scrambling around in an attempt to loosen monetary policy that’s already about as expansionary as you can get. The BOJ unexpectedly pumped another $126 billion into its bond buying program and has opened the door to negative interest rates. The Japanese yen (JPY) initially fell after the announcement but finished the day in the top spot in hopes this measure will invigorate growth.

Government officials came to a unanimous decision to move forward with this policy and the central bank said economic growth had come to a pause. Many economists are calling for a third quarter contraction, so the government has delayed its intent to stop these purchases by six months, to December of next year. With interest rates already at zero and deflation always at the doorstep, officials definitely have their work cut out for them when it comes to stimulating growth. It looks like we’re entering a period where both the markets and economies are relying on government intervention to do the heavy lifting again.

Japanese exporters have long been critical of the relative strength of the yen as it has averaged 78.81 over the past year and is well above the comfort level of 82 that was indicated by the government. At the end of the day, the yen was marching closer to the 77 handle, so the stimulus measures could act as a double edged sword.

Speaking of QE measures, we did see the minutes of the previous policy meeting in the UK. There was a unanimous vote by the BOE members to maintain their bond purchases in September, but it did reveal some differing opinions about the future since inflation has remained on the sticky side. The pound sterling (GBP) was a part of the crowd whose returns yesterday were basically breakeven. Policy makers obviously cited the European debt crisis as a concern but they did mention a slight increase for industrial production.

If we take a look at the currency that had the worst report card yesterday, the South African rand (ZAR) reminds me of that Johnny Cash song “I’ve Been Everywhere”. Moving from first to worst in the course of a day isn’t anything new, but it did manage to lose 1% yesterday after gaining 1% the day before so these swings didn’t get it anywhere. The latest news came about in the way of July retail sales showing quite some disappointment as it resulted in a 4.2% annual gain, which was much lower than the previous figure of 8.6% and the initial estimate of 7.2%.

I feel like a broken record since there hasn’t been much variety lately, but S&P affirmed Australia’s AAA long-term sovereign credit rating. They cited its amply fiscal and monetary policy flexibility, economic resilience, and a financial sector that appears to be sound. We also had a Swedish central bank member say that its most likely interest rates would remain on hold in October and another Brazilian government official said they expect the low interest rate policy to continue into next year.

As I came in this morning, we’re seeing a pretty good shot of risk aversion in the markets as manufacturing took a hit in the euro region and is currently feeding the global growth bears. If we include a slowdown in Chinese manufacturing and a fall in Japanese exports, it’s just the makings of a risk off type of day. With that said, gold is trading about $10 lower and silver is sitting on a 1% loss so far today. It’s going to be interesting to see if the US trading session will pile on top of these losses or if they feel enough damage has been done.

Then there was this… I saw an article in The Wall Street Journal that doesn’t exactly exude much in the way of economic confidence. Bank of America is preparing to slash 16,000 jobs by the end of this year, close many branches and scale back its mortgage operation, according to a document being circulated among senior executives. The bank’s Merrill Lynch unit would expand its role as an investment banker to become a major force globally.

To recap… The spotlight on Europe eased a bit, but euro zone construction output fell lower. The housing market took a step forward as housing starts and existing home sales both showed improvement from July, although building permits slipped a little bit. We’ll see several reports this morning, but that will do it for this week as nothing is on the docket for tomorrow. Japan joined in and instituted another QE injection into their slowing economy. There was much else going on but the BOE did unanimously vote to continue adding stimulus in September.

Mike Meyer
for The Daily Reckoning

The Daily Reckoning