Uncommon Ineptitude

With uncommon ineptitude

Frau Merkel has failed to conclude

Her efforts to build

A new German guild

Thus Germany’s now largely screwed

 

An eloquent testimony to the current market malaise is this morning’s price action. Despite the news that Chancellor Merkel’s attempts to form a coalition government, after nearly two months of talks, have finally failed, the DAX is actually higher on the day by 0.3%. While it is true that the euro has edged lower by 0.1%, that seems a remarkably blasé reaction to what I believe is extremely important news. From Germany, it seems that the economically minded FDP wouldn’t agree to close every coal-fired power plant along with all the German nukes just to join the government. Given that Germans already pay the highest electricity prices in the developed world ($0.36/KwH compared with the average US price of $0.13/KwH), the FDP simply couldn’t countenance further hamstringing of German industry. Meanwhile, the Greens were also strongly advocating for loosening the immigration restrictions recently put in place, which was poison to the CSU portion of Merkel’s party. After all, the far-right AfD party now holds 12.6% of the Bundestag having campaigned largely on that issue alone. It strikes me that this effort was doomed from the start and so it cannot be a great surprise that it has failed. There are now two potential outcomes for Germany; either Merkel continues her rule with a minority government (a historical first in Germany), and one that will quite obviously be much weaker than in the past; or snap elections need to be held in the next several months. Since she was first named Chancellor twelve years ago, Merkel has never been so weak. This is a distinct negative not only for Germany, but also for the whole of the EU, and by extension the Eurozone. When the largest member of your community is weak, what does it say about the rest of the community?

And yet, the market continues to look at the recent growth story from Europe and remains convinced that the ECB is going to taper, and eventually end, QE on schedule next year, and that prospects in Europe remain solid overall. Once again, political imperatives don’t seem to be having much impact on market activities. Perhaps this is the biggest change that we have seen since the financial crisis in 2008-09 and the central bank response. Historically, when governments fell, or other political crises erupted, financial markets were thrown into disarray, at least temporarily. But the great QE experiment of the past decade has anesthetized investors so completely, that anything short of a nuclear war seems insignificant (and let’s hope we don’t find out that impact!) It is with this in mind that I once again am forced to ask, how can it be that QE can support markets but QT (quantitative tightening) will have no impact? I fear both central bankers and investors are deluding themselves with the idea that the Fed’s shrinking their balance sheet and the end of ECB QE will not matter. If it mattered on the way up, it is going to matter on the way down!

Which brings me to my other point this morning, the remarkable increase in the number of commentators who are concerned that a significant correction is not only long overdue, but likely to occur within the next twelve months. While I have been in this camp for a while, it is becoming a much more popular stance. Certainly the price action in some corners of the market (high-yield bonds anyone?) has started to look a little less euphoric. Similarly, a look at some less followed data shows that mortgage delinquencies are rising, as are those of credit cards and student loans. Despite a rip-roaring bull market in equities this year, and actually for the past eight years, under-funding for public pensions remains significant nationwide. The point is that even though the headline GDP data has perked up lately, there are numerous issues extant that can come back to haunt the market. Remember, this is a market that hasn’t seen a 3% correction in more than a year, a highly unusual circumstance due solely to the central banks’ ongoing monetary policy stance. As that stance changes, so will price action. Mark my words!

Which brings us to today’s markets. As Thanksgiving week opens in NY, the market is uninspired. The dollar is mixed, with both gainers and losers, however the only notable mover was CLP, which has opened this morning lower by 1% after weekend elections left the market’s favorite son, Sebastian Pinera, with a smaller than expected (hoped for?) lead ahead of the final round of voting next month. Otherwise, movements have been well within 50bps across both G10 and EMG blocs. The data story this week is similarly uninspiring with the following on the docket:

Today                                 Leading Indicators                                       0.7%

Tuesday                             Existing Home Sales                                    5.40M

Wednesday                        Initial Claims                                                240K

Durable Goods                                              0.4%

-ex transport                                                0.5%

Michigan Sentiment                                    98.0

FOMC Minutes

 

And that’s it. Arguably, the FOMC Minutes would be the most watched event, except for the fact that they are released at 2:00pm on the day before Thanksgiving, which means that most of the market will be gone for the holiday already. We also hear from Chair Yellen tomorrow, and then next week, Jerome Powell will be testifying at his confirmation hearings at the Senate. But the reality is that this week is shaping up to be extremely dull in the US. Equity futures are little changed this morning after a less than inspiring week last week. Treasuries remain in a tight range and oil has found a top around $56/BBL. It is hard to see something changing views this week short of a miraculously positive outcome from the tax reform debate in Congress. And I wouldn’t bet on that!

 

Good luck

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