Each month I want to start with the themes that are having the most impact on the markets or which believe will be the most important driver in the next month. The focus will be on foreign exchange, fixed income, commodity and global stock markets. It is not supposed to be specific stock recommendations but key events that will drive markets.
The Greece problem – Some are calling this the “Ne Lehman” but what this issue really represents is the next leg of the credit crisis. The over leverage credit problems were not solved but switched from private to government extension of credit. Now we are seeing the potential failure of governments who over levered.
Key questions:
Will there be a bail-out? Yes, the form is unclear and this is what is taking the market lower. he timing is also unclear. This could be an overhang for weeks or months.
Will there be contagion to the other PIIGS? Yes, Greece is small The bigger potential problems are Spain and Italy.
How will this carry over to other regions and markets? The banks have significant exposure to the PIIGS.
China monetary policy – The increase in reserve requirements last month suggests that the run-away growth of Chinese credit may be curtailed. Certainly, it will not reverse but a change or deceleration of credit will have an effect on global markets. We are already seeing it with copper prices. We are seeing a reaction with the RBA not raising rates.
Key questions:
Will the impact of tightening regulation have an impact on the Chinese economy? Hard t say in the short-run, but the credit will have to slow.
Will this action be followed by more? Sales have slowed in real estate but lending is continuing. These is a bubble.
Will this lead to a global slowdown especially in the commodity markets? We are already seeing this in copper.
Monetary exits – The Fed is supposed to end their purchase program of mortgages next months. We are already seeing some dismantling of Fed credit programs. The BOE is also talking about reducing their quantitative easing. The markets have become addicted to cheap money, so it is unclear whether the Fed or other central banks can wean economies off of their programs. The next sixty days will be a significant test of the resolve of central banks to cut exit programs.
Key questions:
What will the Fed do with their mortgage purchase program? This is still a wild card. Fed economist say that an end of the mortgage program may add 100 bps to fixed mortgage rates.
What will be reaction to any Fed action? It is hard to own mortgages in this environment.
The deficit questions – We now have an idea of what the 2011 deficit will be, over $1.5 trillion based on the government’s aggressive growth forecasts. Debt to GDP was 83% for fiscal 2009 for just the public sector and is set to hit 94% in 2009, 99% in 2010 and 101% in 2011. Taxes are going up and so are spending as well as continued entitlement plans which the government cannot easily cut back.
The book This Time is Different by Ken Rogoff and Carmen Reinhart has reached #23 in the Amazon sales count as of last week and is #1 of all business books. The debt problem is not going away and will be a theme that continues to overhang the markets. Can the markets handle the continued increase in debt coming to market., The sovereign problems of other countries actually may be a help for the US as the capital has moved back to the US, where else can the money go?
Key questions:
What is the link between debt and interest rates?The research is mixed bu the size of the current problem is unprecedented. We do know that the surprise in deficit ill be more important than the issuance. However, the Fed purchase program has made a difference in rates.
What happens when you mix large deficits with less quantitative easing? Rates will move higher. The qustion is how much and how fast.
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