The market faces another big week of data, but the biggest potential mover is the Employment Overview that comes out on Friday, a day when the market is closed. Here is what is coming. ISM Manufacturing Data and Construction Spending come out on Monday, Auto Sales and Factory Orders on Tuesday, ADP Employment, EIA Petroleum Status, and Non-Manufacturing ISM on Wednesday, Chain Store Sales and Employment on Thursday, and the Employment Overview, Monster Employment Index, and Consumer Credit on Friday. The oil inventory report is another potential mover as the market has shown it is worried about the effect of the recent rise in oil prices on the economic momentum …
As I have said, the debt issues in Europe are far from resolved, but momentum is moving in the right direction. If given enough time and space, the politicians will fix it. They have no choice. I know, I know Europe is not newsworthy these days, but a reader has proposed an interesting question that points directly to the issue, so here is the question and my thoughts on the matter.
Why is the market ignoring the potentially explosive situation in Spanish and Italian banks? It is obvious to any educated trader that the only thing keeping then from collapse is the unprecedented amount of liquidity being pumped into the system.
The market is hardly ignoring anything in Europe, particularly the banks in Spain, Italy and elsewhere. Whether you see it or not, the market is watching the situation closely, very closely, and it appears that the market is willing to wait and see, particularly with Spain and Italy. Currently both countries have ten-year bonds yielding in the low 5% range. Aside from Portugal (11%) and Greece (21%), these are the highest yields in Europe. Although the market feels better about the fiscal situation in those two countries now than it did last winter when the rates were pushing above 7%, it clearly is watching.
As to the banks in those countries, the market sees the “unprecedented amount of liquidity being pumped in” as a positive, not a negative. The excess liquidity is insurance, not needed capital. That money tells the market the likelihood of financial collapse is less when banks are OVER-capitalized. Had we done what Europe is doing now (over-capitalizing banks, bank reregulation, and facing down the debt) in 2008, it is likely the financial collapse would not have happened. Arguable, yes, but the Fed pumping unprecedented liquidity into the financial system after the fact seems to have worked. US Banks are getting healthier.
My issue with your thinking is you assume the banks in Spain and Italy cannot stand on their own without the liquidity from the ECB. You would be right if both countries were continuing their old ways, but both countries are implementing harsh budget cutting measures that further reduce the likelihood of financial collapse. After a period of contraction, both economies will begin to recover, as both countries have also placed economic stimulus in their current budgets. This too will strengthen the banks, which are backstopped (not propped up) with the liquidity from the ECB. The market sees this as well, I assure you.
Finally, when the economic turns happens, the ECB will slowly withdraw the liquidity you reference, interest rates will rise to the market level, and the fiscal issues of all countries will slowly diminish. We are seeing the beginning of this phase now, but all will take time and patience. For now, the market seems patient and willing to give the time needed.
Trade in the day – Invest in your life …
