Policymakers Powerless Against Tattered Fundamentals

Morgan Stanley recently revealed that the market rallies we saw from 2009 through 2011 were not simply fueled by monetary accommodation. It was a real improvement in economic data that added to the liquidity, thereby pushing markets higher.

That suggests the market can’t sustain rallies on monetary largesse alone. Some, however, would hope otherwise. From Reuters:

What’s for sure is that quantitative easing, whereby the “Big Four” central banks have for four years effectively created new money by expanding their balance sheets and buying mostly government bonds from their banks, is back on the agenda for all their upcoming policy meetings.

With that, I want to ask:

Might more QE rhetoric coincide with a stretch of better-than-expected news that serves to support markets and temporarily postpones a market calamity?

After all, the mood has turned exceptionally sour since key players in the euro zone need to repeat elections and squeeze through more sovereign bailouts despite no financial or social foundation from which to build.

And let’s not forget the long list of data points indicating China is slowing more than expected and intended by Chinese officials.

This tells me that the U.S. economy, rightly or wrongly, is the only thing holding up the markets now!

What to Do When Things Look
So Bad to Seemingly So Many

I expected a consolidation or correction period after the sell-off we saw in May riled up so many new doom-and-gloom forecasts. To some extent we’ve seen the correction materialize. And technically there is scope for further correction. But I wonder if there will be any near-term fundamental support to kick up some optimism and underpin an extended corrective rally.

That support could take the form of:

• Adequate loan growth in China through June/July
• Optimistic consumer/business confidence surveys in Germany
• An uptick in U.S. payrolls growth in June
• Expansion in global PMI numbers

Something like the above, or perhaps a string of less-important data, could fuel an extended corrective rally. In the short term, and based on technical analysis, I think it makes sense to stay open to this potential. That means we’d see a bounce across all markets, though the move may be more muted in markets outside the U.S.

So if you are a currency trader using the euro as a proxy for risk appetite, might June’s rally extend through 1.28?

Sure, that’s indeed possible. But when the fundamentals stink … they stink … which is where the euro zone is now. And eventually they come back with a vengeance to overwhelm the potential rally set-up I’ve discussed today.

I think the risks are too great now to take any short-term, long side positions on the euro. But if you’re considering some, I suggest you mull over these points before acting:

• The Austrian finance minister said Italy, not Spain, is the next country due for a bailout.
• Rising yields like we saw this week could force Italy into needing a bailout within a few weeks.
• In Italy, industrial output is falling; unemployment is rising; GDP will fall; national income and consumer demand are falling. Debt as shown in the chart below is currently at about 120 percent of GDP, and rising.

• The European Commission is considering easing the terms on Greece’s bailout regardless of what happens in Sunday’s election.
• German Chancellor Angela Merkel may be conceding a bit on the implementation of a redemption fund that distributes liabilities across euro-zone economies, i.e. debt sharing. But Germany’s finance minister suggests such a pact is not feasible because it breaches European treaties regarding shared liabilities.

Simply put: As long as the fundamentals stay weak, any monetary fueled rally in the euro will last hours or days, not weeks or months.

JR

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