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The Economy and the Credit Market OInvestor optimism has put in for a dramatic recovery his past week; and as a natural side effect, risk-based assets have rallied while the safe-haven US dollar has tumbled. Given the cumulative interest that has developed behind this single currency as a harbor from growing risk over the past seven months, a sustained decline would be expected at least as long as there is momentum behind the sentiment shift. However, over a longer time frame, the dollar’s own fundamental background would begin to factor in for positive effect. Both growth and interest rate potential for the United States is better on a relative basis than many of the nation’s industrialized counterpart. So, while the 12-month forecast for interest rate hikes may be at its lowest level in just over a year (with only 36 bps of cumulative hikes priced in for the period), the potential for market-based and yield returns from US assets are still set at a premium to their European and Japanese counterparts. That being said, the world will end over a long enough time line. Given the short attention span of the speculative masses, risk appetite will more than likely take up the charge for guiding the markets once again. For the current upswing from the capital markets, it isn’t a stretch to suggest that this phase is still a correction and more importantly that it contradicts the fundamentals behind investor sentiment. Uncertainties surrounding the EU’s financial stability have grown over time; and news that furthers this particular threat will eventually curb greed and reignite fear. |
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A Closer Look at Financial and Consumer Conditions
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| If we were to take the bearing and momentum of speculative market benchmarks for face value, we would be led to believe that financial stability has markedly improved over the past week. However, an objective review of the actual conditions facilitating investment and lending worldwide tell us that circumstances have actually deteriorated with time. Globally, the EU is still the gravest concern when it comes to credit stability with warnings from the European Commission that certain economies’ debt could ‘snowball’ out of control and given speculation that Spain may be forced to soon ask for assistance. China is another concern with officials warning of a dramatic slowdown in markets. State-side, Standard & Poor’s warned many high-yield companies are at high risk of default. | The economic picture for the United States over the past week has leveled off from its steady pace of recovery. From a round of top tier economic data, we have seen a notable drop in consumer and housing-sector activity. Accounting for approximately three-quarters of the nation’s output, consumer spending as measured through the retail sales report for May dropped 1.2 percent. When the influences of gasoline, vehicle and building materials were extracted from this report, consumption was better; but this data cannot simply be brushed aside. Acting as an immediate and direct contrast to spending habits though, consumer confidence for the current month reportedly rose to its highest level since January of 2008. This may not hold however, as wealth tied up in housing cools. Housing starts dropped 5.9 percent last month. |
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The Financial and Capital Markets It seems investors have suddenly found their appetite for higher returns, regardless of the risks that are involved. Sharp rallies from equities, commodities and high-yield currencies means the bearing on sentiment is impossible to deny. However, this drive may not last long. Price action is by definition the product of crowd behavior; but the crowd itself follows the path fundamentals lay out over the longer term. The current updraft in confidence may simply be a natural correction after many of the top fundamental concerns have been dissected and absorbed into the fair value of the market’s benchmarks. To visualize this development, we can point to EURUSD and its development around fears that the European Union is heading towards a financial disaster that could roil the world’s credit markets. After seven months of a nearly uninterrupted decline, much of the euro’s excess premium (on speculation that the world was looking to this currency as an alternative reserve) has been worked off and a significant level of the EU’s own troubles have been accounted for. Naturally, after a 3,265-point decline, a reversal can be hearty. The same cannot be said of the S&P 500 which retraced less than a third of its 2009 rally. Most other capital asset classes are in similar positions; and the closer they come to their recently set highs, the more critical participants will be of fundamentals and further advances. All that is need to put speculators back on the fundamental track is a surprise announcement – which are common nowadays.
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A Closer Look at Market Conditions
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| Many of the benchmarks for the various capital market asset classes have cleared meaningful resistance levels through their respective recoveries. For equities, the S&P 500’s push above 1,105 and the Dow’s advance beyond 10,300 have added technical fuel to a reversal that began less than two weeks ago with a critical hold eight-month lows. A similar situation has developed for commodities. US crude has shaken its own congestion pattern with a breach of $75.75 and has retraced nearly 60 percent of its collapse through May. Offering reason for doubt, however, the benchmark 10yr T-note has not moved far from the yearly high set in May. | With the climb in asset prices, implied volatility (an assessment of risk for most) has declined. This is a natural cause-and-effect whereby bullish interest is associated to lower levels of volatility while declines are labeled irrational and thereby more worthy of higher uncertainty. However, as a leading indicator, there readings are often poor performers. The bullish climb the financial markets have put in for is considered fundamentally shaky; and higher measures of market confidence and commitment reflect this state. Libor rates continue to rise as counterparty risk grows. What’s more, default risk in the US has climbed to an 11 month high while European sovereign debt spreads have soared to Euro-era highs. |
Written by: John Kicklighter, Currency Strategist for DailyFX.com
E-mail: jkicklighter@dailyfx.com
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
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