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Friday June 4, 2010 - 22:32:49 GMT
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Forex Blog - Contagion Never More than a Headline Away (FXA)

Unfortunately for the risk-on crowd today there were a number of headlines today that raised the contagion alarm.

Hungary’s new center right government seemed to have a Joe Biden day…saying things in public that only have downside like Hungary is the next Greece, and the prior Socialist-led government left the fiscal balances in much worse shape than they let on publicly.  Thursday saw a stern warning from the EU’s Barosso on the need to get the deficit under control adding to the suspense.  Then today we saw a real rush by Hungarian banks to buy CHF to cover loans made domestically in CHF (to capture a lower borrowing rate for customers…indeed so popular in the mortgage market that most loans written were in CHF in the last 3 years).  RBS said today that 61.5% of all private loans in Hungary were made in CHF.  I saw another stat on Austrian investors hold over 40% of all public issued debt from Hungary.   If I had to wager, the SNB saw a wall of bids from Hungarian banks in CHF today (and yesterday) and simply stood aside and after the fact it could brush off any suggestion it is targeting EURCHF above 1.40 or any level…just aiming to prevent unjustified appreciation.  Hungarian banks buying CHF with HUF and likely EUR sent EURUSD sharply lower. 

It also does not hurt the feedback loop between EUR and stocks when French Prime Minister Fillon set the record straight on EUR policy in core Europe…what’s better than parity?  Is the euro driving stocks down?  Are stocks driving the euro down?  It don’t matter much (good punch line from a cowboy in Montana and a lawyer from LA on his Montana ranch) when feedback loops are up and running.  While I never would argue that currency intervention will mark the end of the decline in the euro, it will be a significant step in the bottoming process, especially if it is accompanied or preceded by an important policy announcement like cutting the refi rate to a zero bound and the deployment of quantitative easing…all of which still seems some distance away.  So we have proxy official support for the euro from the likes of the SNB, BIS and PBOC.  How long before the likes of US Treasury Secretary Geithner engages in verbal intervention t support the EUR as European officials dither over what if anything to do about pressures on sovereign credits running now into core Europe as witnessed today with Belgium spreads and CDS blowing out, and the ongoing pressure on European banks (derivative loss rumors notwithstanding). 

I think today also saw a weaker-than-expected US jobs report feed contagion (and the feedback loop)…events outside Europe and outside the ability of most officials apart from US gvt to influence were driving risk-off trades.  Never believe that one month’s jobs data make a trend and the May private payroll gain was disappointing it followed five months of impressive growth.  Nonetheless,  if you are inclined to agree with Shiller and Akerlof hypothesis that emphasizes the collective mood of economic agents at any given time guiding economic behavior, then one (me) can argue that stock prices and changes in stock prices reflect the collective mood of agents in the economy, particularly firm behavior.  While firms base business decisions mainly on orders, there are times when expectations about the future overwhelm signals from orders and managers adjust…much as they did in 2009 to the 2008 financial crisis.  Stock gyrations feed certainty on the way up and uncertainty on the way down.  Surely the Fed and White House operated with this notion in mind in the post crisis period…even with housing prices falling; get stock prices up first and the rest will follow.  Well that was going swell until Europe’s problems surfaced and sent uncertainty skyrocketing and stock prices sharply lower.  My point is that the sell-off in stocks in the last 8 weeks has undermined firm hiring.  Have a look at the attached graph which overlays the S&P with total non-farm employment…big swings in stock prices lead large periods of hiring and firing…okay obvious as stocks reflect expectations about earnings and the business cycle.  At Wal-Mart’s annual meeting this week the Vice Chairman of the firm downplayed expectations about sales, store traffic and revenue noting competition and high unemployment…and said Wal-Mart was lowering prices to boost store traffic…may not be deflation but surely has the seeds of deflation in this story.

Sinking stock prices, as we now have before us, are reason alone to be very worried about the performance of the real economy.  Firms hit the brakes on hiring in 2009 as stocks troughed and started hiring again in late 2009 when prices for shares bounced 40-60% from the spring lows.

I don’t like what I see in stock prices (the sell-off) and what it portends for employment, income and consumption.  With the US unlikely to export its way to prosperity (or even a 3% growth rate to stabilize the labor market), and the fiscal stimulus nearly exhausted, I don’t have a strong feeling about US fundamentals and risk asset prices and FX ahead.  And as we all know by now the world remains very interconnected and if things go badly wrong in Greece, Hungary and in time core EZ states like Belgium, the US is impacted…directly in asset prices (risk assets) like stocks and indirectly in employment.  Even if you think the economy will not double dip, stagnation or 1-2% rate of growth will likely see the labor market deteriorate ahead and demand a fresh policy response (both fiscal and monetary).  In the very near-term look for the world to bring pressure to bear on Europe to stop dithering in denial and address its compromised banks and even more compromised states.

David Gilmore





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