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Giving Markets What They Want
The rally is real, but political risks remain in Germany says EmiratesNBD’s Chief Investment Strategist Mark McFarland.
September 13, 2012 11:58 by kippreport
US Federal Reserve chairman, Ben Bernanke, clearly set out his need to see deteriorating employment data before activating further monetary stimulus. That is, to a degree, what we got. Thursday’s ADP employment survey wasn’t weak. It came in well above expectations. But the overall tone of US labour market numbers hasn’t been good recently. And Bernanke can’t add stimulus measures after an election for fear of looking like he’s unwilling to act beforehand, when it’s most needed.
In Europe, the ECB’s decision on Thursday to announce a bond-buying programme that satisfied most people’s needs was a masterstroke of politics, if not financial economics. Spain and Italy got an unlimited commitment to purchase their bonds of maturity 2-5 years, while German fears of fiscal profligacy were placated by conditionality. The latter locks in nations to IMF style restructuringprogrammes that can be terminated if funds aren’t used properly or if budget reduction targets aren’t met. And Spain and Italy got what they wanted because they will only become recipients of financial assistance from dedicated European bailout funds if they specifically ask for assistance – both claim they don’t need any assistance.
The only strange thing about the plan was the announcement that the funds that have already been spent by the existing ECB assistance plan will remain senior in lienterms to new funding outlays(in the event of a bankruptcy the funds will be the first to be repaid). It has been suggested that the ECB knows a restructuring event is imminent in Portugal (the main beneficiary of ECB assistance to date). But in all, markets have liked what they got.
In Asia, the Communist Party has complemented People’s Bank of China monetary stimulus measures by introducing infrastructure spending plans worth up to 3% of GDP. This makes sense in that the programmes aren’t roads to nowhere or further additions to China’s collection of ghost towns. It’s long-term infrastructure – metros, port facilities, water plants etc.
These play two roles: first, they create jobs and second, they create the strong impression within a Communist Party with a passion for big ticket events that something solid is being done ahead of the hand-over of authority in the party at the end of this year. Naturally, commodities and foodstocks have gained.
From a tactical perspective, we are advising clients that this rally is real, but that there are serious pitfalls if proper risk management isn’t employed. On September12, two days from now, the German courts sit to determine whether the European Stability Mechanism (ESM) is legal under German law. It’s not clear that the German legal system will decide that Germany’s constitution allows for large scale assistance of other nations, particularly those with a much lower retirement age than Germany’s.
A no vote would put an abrupt stop to market euphoria as it would reduce the size of Europe’s bailout fund by at least one-third.
Mark McFarland is the Chief Investment Strategist at EmiratesNBD.
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