Its been a while since I talked about markets. S&P has been stuck range bound between 1100-1280 for sometime now. There are two opposing strings that are trying to move the markets.
Positive news is that US economic data is getting better and better. Initial Jobless claims numbers have dropped below 400,000 and show a continued slide down, consumer confidence is up, inflation is ticking up all of which are indicators that demand is up. Also S&P earnings showed solid growth.
On the flip side we have Europe, a bloody mess to the say the least. The main catalyst is the increasing rates that european governments like Greece, Italy, Spain, Portugal and Ireland have had to pay to rollover their debt. Greece is in full bail out mode, their yields don’t matter anymore (i think they are in the range of 60-100%). The real danger is Italy, its yield has spiked to close to 7%, by yield i mean yield on 10yr+ debt. Italy has over 1T debt in all and needs to rollover 150bln in 2012 and another similar amount in 2013. At these yields their interest payments will eat into any GDP growth pretty fast. The rise in yields is in itself not such a big deal, but it the liquidity crunch that it is creating that is causing a lot of panic.
How does this cause a liquidity crunch you ask? Well serves you right for asking, here goes…. It is a common practice for banks to buy the govt issued debt and they hold this debt on their balance sheet. Suppose one of the govts decides to default, then essentially it is a bankruptcy so all the creditors will have to take a hit. Govt bonds sitting on bank balance sheets will now be worth say upto 50% less. Guess what happens to the banks then? These banks could now go bankrupt, depending on how much of this debt they hold. There is constant flow of credit between banks to settle their overnight positions, sometimes banks borrow from govts, and at other times they borrow from other banks. This possibility of a bank going bankrupt causes fear and other banks stop lending to it. There is the liquidity crunch that I talked about.
Now let us take it a bit further, since so many european govts have had problems, the euro as a currency itself is at risk of failing. So this cause all kinds of institutions to run to USD and sell Euro. This causes euro crunch. That is why you see all asian currencies being hit as well. For eg INR (indian rupee) vs USD jumped from 44 to 53.
There is so much to say, i guess i will continue in Markets – IV at a later date. Meanwhile think about what the ECB and other Central Banks have done so far to ease this european mess.
