After vehemently denying that it needed outside help, Ireland did what the market had expected: It applied for a three-year loan of up to 90 billion euro (the equivalent of about $122 billion) from the EU and IMF to shore up its bank problems. Exact details of the bailout loan package will be finalized in the upcoming days. Confidence in Ireland eroded in recent weeks as fear that the country’s cash-strapped banks could cause a domino effect through its economy sent Irish government bond yields skyrocketing, making it even harder for Ireland to raise capital in debt markets.
The lack of concrete details in the Ireland bailout plan has further sparked uncertainty in markets while concerns linger that Portugal and Spain are next on the bailout list. Yields for Portuguese and Spanish government bonds have similarly risen sharply lately. Leaders from both countries have publicly stated that the bailout will keep Ireland’s financial problems contained and stabilize the euro-zone, but as we have seen in Ireland’s case, public words of assurance don’t carry much credibility. There is also Portugal and Spain, in which investors don’t have much confidence (rightly so), making more international intervention likely and even necessary.
Europe’s debt problems aren’t going to be fixed easily, and will time and again thrust its ugly head into the spotlight. We expect the euro currency to eventually go the way of the dinosaur, but for now, despite terrible government balance sheets, a catastrophic government default in the near future appears unlikely. The euro has retreated on the Ireland news. Although the dollar isn’t exactly on firm footing either, we expect ongoing uncertainty in Europe to be a headwind for the common European currency.
Exacerbating the markets’ worries, North Korea is back in the news. The reclusive communist country launched artillery fire on South Korea in a border region, killing two South Korean soldiers, wounding several other soldiers and civilians, and setting houses ablaze. South Korea returned fire. The attack comes after North Korea flexed its muscles to the world by showing off a new uranium enrichment facility over the weekend. The latest decisionbar events are escalating fears that a large scale conflict could break out in the tense region, potentially dragging other nations into the conflict. The Korean Peninsula remains a ticking time bomb and bears watching. Should a larger conflict erupt, it would likely put more downward pressure on stocks worldwide.
China’s monetary tightening measures, of course, also remain on investor minds. Late last week, China raised its bank reserve ratio requirement by 50 basis points (half a percentage point), the fifth hike this year, and hinted at further increases in the future. In recent weeks, China has also increased elliott wave interest rates, and sold off raw materials from stockpiles, while enforcing price controls on certain products, namely food.
The concern is that the Chinese government’s tightening grip on the economy could derail the economy and slam the brakes on growth, but having shown strength again and again, the Chinese economy is unlikely to lapse into a recession. The tightening of the reins in China could actually help other countries around the world by temporarily cooling the growth of commodity prices. Fast-rising input costs increase business costs and are eventually passed down to consumers, acting as an effective tax and potentially hurting the economy—recall the first half of 2008. Controlling inflation should lead to more sustainable growth for the long run for China and relax some raw material price pressures on the developed world, which does not have the growth to tolerate increasingly expensive commodities.
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Stocks are supposed to go down, but they don’t want to just yet.
World stock markets declined sharply Monday. The trouble started in Shanghai, where the benchmark index fell 5.8 percent, its biggest loss since November. The Dow Jones industrial average’s 2 percent decline that day actually understated the weakness here in the U.S.
The widely stated reason for the tumble was renewed worries about the strength of the global economic recovery. But there doesn’t have to be an official reason. In my view, it was simply a matter of overdue profit taking.
After all, news on the economy has actually been improving. And the profit taking lasted just one day. U.S. stocks have since made up for Monday’s lost ground. At today’s market close, the S&P 500 was actually slightly higher than its closing level last Friday.
My long-term view for both U.S. Treasury securities and the dollar is unfavorable. In both cases, it reflects concerns about the massive amount of debt in the U.S., exacerbated by the necessary but costly government programs to bail out the troubled economy and financial system. This makes our government debt securities and our currency relatively unattractive.
For Treasury issues, there are also worries about the large quantity of them held by foreign investors. It’s generally in the interest of these investors to support their large Treasury stakes. But there are also signs that they want to diversify away from Treasury issues, and that they won’t be as willing to buy as much as before even as new issuance will jump in order to fund our mounting debt.
But sometimes short-term trends run counter to the long-term ones.
China and Japan, the world’s largest creditors to the U.S., bought longer-term Treasury notes and bonds at a record rate in June. It’s also worth noting that demand for Treasury securities has risen from U.S. households, which have finally started to save more after years of spendthrift behavior.
China and Japan were heavy sellers of short-term T-bills in June. But total foreign net buying of Treasurys excluding Treasury bills hit $100.5 billion in June.
So while we continue to worry that the U.S. government’s aggressive stimulus program will eventually fuel inflation, this is not yet a major concern for foreign buyers.
In June, yields on Treasury notes and bonds hit their highest levels for the year, with the 10-year yield briefly climbing above 4 percent. That yield has now fallen to below 3.5 percent amid strong buying. Yet investors supposedly are turning more bearish on Treasuries based on the belief that yields will rise (will lower prices) as the economy gradually improves
Meanwhile, the dollar benefited in 2008 as a safe haven amid a risk-averse, global flight to quality during the economic crisis. But as the world’s investors regain a taste of risk, they tend to move out of dollars and into other vehicles that offer better profit potential, particularly in a recovering economic environment.
For the dollar, the direction is more clear: down. While demand for Treasury issues has remained relatively strong despite perceived economic improvement, that same factor is putting pressure on the greenback
The Dollar Index, which the Intercontinental Exchange (a publicly traded global electronic marketplace) uses to track the dollar against six major currencies, is now at its lowest level in almost a year. Stronger economic data tend to weaken the dollar as investors became more comfortable buying riskier, higher-yielding assets elsewhere.
A potential catalyst for a higher dollar would be if the Federal Reserve were to start raising short-term interest rates again. But that’s not in the cards yet.
The big picture for the world’s economy is this. First, many emerging-markets economies are doing well. Second, the economies of many more mature nations stabilized in the second quarter. The U.S., however, continues to lag, although growth is expected to return in the current quarter.
The Organization for Economic Cooperation and Development said this week that its 30 members, developed-market nations, collectively should start to grow sooner than previously expected. But the group’s economic recovery will probably still be weak.
The OECD said its member countries stabilized in the second quarter, led by export growth in Germany and Japan. The OECD’s report said that gross domestic product (GDP) of the OECD’s major seven countries (Canada, France, Germany, Italy, the U.S., the U.K. and Japan) slipped 0.1 percent from the previous quarter between April and June after dropping 2.1 percent in the first quarter. The U.K. and Italy lagged the most behind, followed by the U.S. at a 0.3 percent drop.
The outlook from Europe, where the OECD is based, is much the same as it is here. For example, the International Chamber of Commerce there said that high unemployment rates and rising public debt in many countries bring concerns about a sustained recovery in the global economy.
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