Yesterday saw two quite different factors influence world markets. Firstly we saw a substantial falls in Chinese equity markets with the Shanghai Composite index falling by 8% in 3 trading days and secondly we saw the Euro zone crisis develop further as Euro zone ministers and officials met without coming to any solution for the two nations, Ireland and Portugal, which are in financial distress at this time. As these two combined then equity markets around the world had substantial falls symbolised by the US Dow Jones Industrial Average falling by 178 points to 11,023.
Overnight we have seen a further development as Chinese Prime Minister Wen Jiabao has stated that China is preparing measures to deal with the inflation that she is currently suffering from. Accordingly there were more fears of an interest-rate rise to help combat her inflationary problems and this led to a further fall of 1.92% in the Shanghai Composite Index making it 10% in 4 trading days and raising the prospect of a bear market developing.One piece of evidence that did arise on the subject was that MacDonald’s have just raised their prices in China, so if you want a Big Mac from Ronald MacDonald you now have to pay more and Bloomberg found Zhang Chen who said “Everybody is getting used to price increases nowadays.” Seeing as not following the party line can appear to affect your life expectancy in China I would suggest for a start that this individual steers clear of Tiananmen Square and any tanks for a while!
Market Movements which may surprise: A failure for QE2?
Whilst the media are concentrating on other matters there are some financial moves going on in the background which may get ignored in the melee. Firstly the US dollar has regained some strength recently with the US dollar index which is trade-weighted rising to 79.25 which is 3.3% above the benchmark of 76.68 I set just before the US FOMC announcement of QE2 on November 3rd. So at this point the impact of QE2 appears to have led to a dollar rise which was far from expected well let me continue with this theme as you see long-term interest rates have risen too as if we look at US government bond yields then the ten-year has risen from 2.57% to 2.85% and the thirty-year or long bond has risen from 3.91% to 4.27%. Just to complete the set the Dow Jones at 11,023 is below the 11,188 benchmark I set. So there you have it as we stand if you measure events since the FOMC’s statement we have a higher dollar,higher long-term interest rates and a lower US equity market! We have pretty much exactly the reverse of expectations and not the result that the FOMC was looking for. There is always the cautionary note that markets particularly at times like this can be volatile and spin on a sixpence but as we stand QE2 has not led to an outright improvement in the markets it was supposed to influence.
Japanese markets cheer events
I add this in because there have been considerable consequences for Japan. Almost without notice or mention the Yen has sneaked above the level against the dollar which led to the intervention on September 15th and now stands at 83.45. This is a subject I have discussed before as I feel that currency intervention is invariably a failure and my main article on this subject was on the 25th of August. I tend to feel that it reinforces my point on the subject that as market attention has moved to QE2,Ireland,Portugal and China and so on that currency trends have reversed for now. Of course there is no actual proof because the intervention took place and cannot be changed. One follow-on effect has been for the spread between the Dow Jones Industrial Average and the Nikkei 225 equity index which had risen as high as 2000 points and is now 1211. Just to add a point of context they were at the same level earlier this year.
The Euro zone crisis: Its’s just like deja vu all over again…..
In case you are wondering the second part of the title is a quote from a baseball coach famous for such things. However there is a serious point if we return to the spring of this year and look at the Greek crisis and compare it to now with the Irish and Portuguese one then it would appear that the Euro zone and its officials and politician’s have learnt nothing. Here is a quote from the beginning of the Greek crisis from here back in March.
The Chairman of the talks Luxembourg Prime Minister Jean-Claude Juncker said
“We think the question (of aid for Greece) will not arise”
One might idly muse as to why they were discussing the subject then.
As the talks continue with no result in sight and all sorts of options being discussed in the media I would like to make the point that having gone through this once surely any half-way competent body would be ready this time. Yet it would appear from all the disputes that the Euro zone was not and indeed is not and the disputes are making things worse, just like they did for Greece.
Another Disturbing Feature
This time some of the Euro zone nations appear to be actively against what is going on. For example the Austrian Finance Minister said the payment of the next tranche of aid for Greece will be delayed until January after the government in Athens missed a revenue-raising target. So we have a clear issue for the Greek programme going forwards as it would appear that at least one country takes the conditions on the loans seriously which is likely to come as a shock to some of the others. Then Finland added to the atmosphere of confusion by stating that Ireland should be forced to put up collateral for any aid.
The European Financial Stability Facility has yet more problems
I have questioned how effective this mechanism it is likely to be ever since it was announced and my first article seriously questioning it was back on the 25th of June . I would like to add an additional feature today and quote from its own website. The first feature is that two countries Belgium and Slovenia have not fully ratified it yet and this may be a reason behind the delay in its use, particularly after the moves above by Austria and Finland suggest that other countries may be having second thoughts. I still have the feeling that Euro zone politicians never actually believed that the EFSF would ever have to be used.
As to how flexible it is let me quote from the EFSF website.
If there is a request from a euro area Member State for financial assistance, it will take three to four weeks to draw up a support programme including sending experts from the Commission, the IMF and the ECB to the country in difficulty. Once euro area finance ministers have approved the country programme, the EFSF would need several working days to raise the necessary funds and disburse the loan.
My first point is that if they expect it to be in operation by Christmas they need to get a move on if you look at the calendar and the suggested timetable. That of course assumes that bureaucrats,officials and politicians can achieve their own timetable as so far this has not been a strength for them.
Secondly I wonder if this will work at all. It was always likely that the EFSF would be called into operation at a time of rising long-term interest rates and yet no-one seemed to consider that as it starts by funding itself in financial markets the funding accordingly was likely to be more expensive than anticipated. Also for some countries they might find that the effect of further borrowing is to raise interest rates on their own debt.Should they then hit trouble they may have to pay a higher interest-rate than the one at which they have used to help another country. It is not impossible that financial markets hit such distress that the EFSF may struggle to borrow much at all. Back on the 25th of June I suggested this amongst other things.
The idea that the EFSF will issue securities or bonds when a sovereign needs help seems to assume that nation is the only problem at that time.Should it not be so then issuing such paper may be difficult or even impossible. What if several are in trouble at once or the problems are associated with financial markets being in trouble themselves?
The UK’s involvement
You know that things are not going well when there is talk of UK involvement in a Euro zone bailout. As I discussed yesterday I have wondered all along if the EU could manage to disburse funds from the European Commission Budget without involving nations which are not part of the Euro.EU officials have continued to imply that the other 9 EU nations would not be involved until now in what I suspect is another case of hoping for the best or misrepresentation. However when I heard that the UK Chancellor George Osborne had said that the UK was “ready to support Ireland” it became clear that we are likely to be involved.
This will cause trouble as the previous Chancellor Alistair Darling said that we would not be involved and will be subject to some criticism should this turn out not to be true. Also whilst one wing of the UK coalition government the Liberal Democrats are likely to support such moves the main party the Conservatives has had quite a few splits on this issue. I suspect a lot of questions will be raised along the line of, how did we get involved in something to which we are not a party?
The lack of any real progress has led to longer-term interest rates rising again in the countries concerned. Irish ten-year government bond yields rose to 8.18% and the Greek equivalent rose to 11.72%. So far today Irish yields are rising again but the situation is plainly volatile and could change at a moments notice.
The nations which might contribute are seeing their bond yields rise too. For example the German ten-year bund’s yield has risen to 2.61% and as we are now possibly a contributor to an aid package the UK ten-year gilt yield has risen to 3.3%. For Spain it is hard to say whether the rise in her government bond yields is from the likelihood of her paying into an aid package or being a recipient (or of course both!) but her ten-year government bond yield has risen to 4.6%. This rise may have further implications for her as her government had spotted that the yields on her debt had fallen and had factored this into her public expenditure which is somewhat awkward to say the least now.
A year on
Last weekend was a year of blogging for me. Apart from the obvious thought of how fast it feels it has gone I have been very happy with the results and progress. Thank you to those who make comments because I believe the quality of them has become a strength of this blog. To add to the feeling yesterday was its busiest day so far.