Worldwide equity correction continues as investors flee Spanish, Italian assets

Tom Tong16/Απρ/2012Currency Updates

Worldwide equity correction continues as investors flee Spanish, Italian assets

Investors remained focused squarely on Spain, Italy and the rising threat of contagion from these troubled economies. ECB data published last week confirmed our view that Spain has lost access to financial markets and is now completely dependent on the ECB for its funding needs. The selloff in Spanish and Italian bonds accelerated. The disastrous news from Europe more than canceled out the mildly positive GDP growth report from China and the more neutral news out of the United States, and stocks continued to correct from their recent cycle highs. Surprisingly, the Euro managed to end the week essentially unchanged against the Dollar. We think that the relative strength of the common currency in spite of the news coming out of Europe is one of the most puzzling financial developments of 2012, and expect the dilemma to be resolved shortly as the Euro breaches its recent support of 1.30 in the coming weeks.


Our lower-than-consensus view on UK growth received strong support from last week data releases. Construction output in February rose 6.1% MoM, but this came on the heels of two double-digit declines in December and January. The number disappointed expectations and bodes very poorly for the sector contribution to growth in the first quarter. Trade data were also negative. Both exports and imports fell, but exports drop was over 4% larger than that of imports. Putting both construction and trade data together, our forecast of flat growth for the second quarter looks to be quite reasonable, and in fact some of the large investment banks were busy revising their estimates lower, to levels close to ours. In FX markets, Sterling moved almost one-for-one with the Euro, rallying against the Dollar early in the week, only to lose all its gains after the publication of the worrisome Spanish bank data we mentioned above and end the week nearly unchanged against both currencies.


Last week the usual litany of awful economic data was complemented by the release of ECB data on bank dependence on its liquidity. It showed a massive jump in the amount that Spanish banks have borrowed from the ECB, up now to EUR318 billion and the largest monthly increase on record. This increase, together with the rise in Spanish bond yields and the sharp drop in Spanish equities back to March 2009 levels is consistent with a generalized flight out of Spanish assets. Only ECB liquidity is keeping this flight from turning into a rout, which means that Spain is de facto fully dependent on official funding, whether this back-door bailout is made official or not. Italian assets had also a rough week, though the situation there does not seem as dire as in Spain, and Italian low levels of net external debt (public and private) probably mean that Italy has still some room for manoeuvre. As long as Frankfurt and Brussels continue to insist on their failed policies of austerity, wage cuts and bank deleveraging simultaneously, that room for manoeuvre will be exhausted soon enough. faced with yet another cirisis, European officials are apparently standing fast in their twin policies of can kicking, ignoring reality and (perhaps most shocking) self-congratulation. Until this changes, we will maintain a very bearish view of the common currency.


The tone of news flow out of the United States turned more positive last week. The trade deficit narrowed sharply, surprising expectations, assuring that the external sector will be a net contributor to US GDP growth. Other high-frequency indicators turned more mixed, with new weekly jobless claims rising 13,000 to 380,000, chain store sales soaring, and mortgage applications finally turning up, in another sign that the housing market is finally ready to provide some uplift to the US economy. The data are still consistent with trend-like growth of between 2 and 3%. Not exactly a boom, but a very good contrast to the disaster unfolding across the Atlantic. hence, we maintain a relatively positive view of the US dollar.


Written by Tom Tong

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