Tuesday, February 26, 2013

A Quick Note on the Markets

From the Financial Times:

Some economists and investors questioned whether political deadlock in Italy would undermine the broader recovery in markets triggered by the European Central Bank offer last September to buy short-dated government debt of ailing eurozone countries under its outright monetary transactions (OMT) programme.

“This definitely throws a spanner into the works,” said Lyn Graham-Taylor, fixed-income strategist at Rabobank, given that the ability to activate the OMT should it ever be needed would be difficult if not impossible for Italy without agreement in both houses.

And therein lies the rub.  Late last summer, the head of the European Central Bank gave a speech wherein he stated he would do whatever it takes to save the euro.  Here are his exact words:

When people talk about the fragility of the euro and the increasing fragility of the euro, and perhaps the crisis of the euro, very often non-euro area member states or leaders, underestimate the amount of political capital that is being invested in the euro.

And so we view this, and I do not think we are unbiased observers, we think the euro is irreversible. And it’s not an empty word now, because I preceded saying exactly what actions have been made, are being made to make it irreversible. 

That speech is the primary cause of the latest overall global rally, as traders took the remarks to mean the ECB would do anything to save the region.  As a result, we've had a good run in the equity markets.  US treasuries have been selling off for the last few months, and the euro has been rising. 

But the Italian election situation completely throws all of these developments out the window, as we will now return to news stories about problems in the EU and their seeming inability to solve their problems.  So long as these problems persist, expect instability to reign in the markets.

That means that for the time being, we're risk off: stocks are under pressure, treasuries catch a safety bid.