The power of four: Q2 corporate earnings, Stress test, Euro zone dominant economic figures and bond auctions, made July a Joy Rally for the risk traders. Particularly the month of July, was the month were the ball was totally lying in the court of Euro zone, where the region managed to pull out happiness out of the proverbial sad land. The ratings agencies took a far tougher tone on highly indebted sovereigns this month than they had bargained for. In the last few days, the rating agencies have downgraded Ireland, Portugal and Greece—hitting the latter two with the steepest downgrades possible—and threatened to cut Spain's rating by two notches. But a bunch of positive news releases and a series of successful bond auctions over shadowed some of these black patches.
Spain, Ireland, Greece, Portuguese, Hungary and Italy successfully tapped bond markets this month in a sign that European efforts to calm an immediate crisis over government debt have taken hold. Moreover, ECB lent banks below forecasted amount, only EUR131b instead of expected EUR250b. Investors heaved a sigh of relief on indications that the banks in Europe still have a lot of liquidity left. Furthermore, the bullish Euro Zone economic numbers signaled that the ECB is likely to refrain from applying additional stimulus measures while the weakening U.S. economic data means the Fed is likely to consider a second round of quantitative easing.
Moreover, the bullish tone towards euro area regained some of its strength after the stress tests showed that only seven European banks required raising capital. At the same time, the U.S. gave more and more reasons for the concern about its economic growth. An astounding fact this month was that, equities did very well despite the Bernanke's dovish testimony about the US economy and Fed still struggling to cope up with possibility of a double-dip recession and housing market just about to sink once again.
The collapse of the U.S. housing market was a critical cause of the Great Recession and sustained growth in this sector is necessary for the stimulus-driven economic recovery to succeed. After improving in late 2009 and early 2010, the housing market appears to be weakening again following the expiration of the homebuyer tax credit by the end of April 2010. Despite very low mortgage rates and improved affordability, home sales and prices remain depressed amid high unemployment and a large inventory of vacant homes persists.
More than 100 banks in the US have now collapsed so far this year and reached to 103- the same day that seven European banks failed a financial health check. With rising bad debts tied to commercial and residential mortgages, the number of US bank failures this year is expected to exceed last year's figure of 140.
A startling fact this month was that despite the US economy showing no signs of picking up, the risky trades had an upper hand, with risk takers wining the game. The onset of Q2 earnings season tested the market, with better than expected earnings overriding the spell of economic worry. Dow Jones industrial average registered a gain of more than 7% till date, overturning the loss of 3.57% seen last moth.
The bullish bias this month was further supported by the outside day on the VIX Index (arguing for lower volatility). VIX volatility index also known as the fear index of the markets declined by more than 30% till date since the beginning of this month, tumbling below the 25 level, after starting the month above the 34 level.
Moreover, the TED spread also fell by more than 11% this month compared to a downfall of just 5.35% last month, which in turn proved to be a good sign for the markets as stock markets are a function of liquidity more then anything else.
However, the biggest winners this month proved to be the euro, which staged a rally from the beginning of the month and since than has not stopped. The currency jump started to 2 month high following the Spanish bond auction and did not budge much thereafter, continuing to build gains throughout the remainder of the month. Euro movements were seen crafting in its own style despite the downgrades and the eerie patches in the equities. Euro has appreciated nearly 7% against the dollar this month, compared to a flat movement last moth were it depreciated against the dollar marginally by 0.43%.
A robust response to positive economic data and successful bond sales by Italy and Hungary yesterday saw the euro rally to a fresh three months high level by the month end. Euro zone peripheral bellwether Italy drew solid demand for its debts as it sold nearly 9.5 billion euros of fixed and floating rate bonds on Thursday, nudging down yields in another sign that appetite for peripheral bonds is returning. Moreover, Hungary also drew better demand than expected at bond auctions on Thursday, less than two weeks after halting talks with the IMF and EU, as the markets took the view that Hungary's finances still looked good despite the policy uncertainty.
The Euro surged to 1.3105 for the first time since May yesterday. The single currency found a support at 1.3055/60 and regained the upside during the American session but was unable to rise back above 1.3100. But the euro was unable to hold this level as stocks corrected sharply during the trading session. The US Treasury bond auction Thursday also weighed on the Euro yesterday. U.S. Treasury prices ended mostly higher on Thursday as investors fled the flagging stock market for the safe haven of bonds, blunting the impact of a soft 7-year auction. However, the bond auction did not prove to be very successful, which in turn did not lead the euro depreciate much as supportive economic data in the form of jobless claims kept the DOW JONES bigwigs in green and keeping the demand for government paper fairly low. The subsequent break triggered volatile moves throughout the session with the market retracing inside the 1.3105 to 1.3059 range several times.
Tepid demand on a $29 billion seven-year note auction Thursday tempered a rally in the Treasury market, pushing the benchmark 10-year note to erase early gains. Prices of shorter-dated Treasuries also gave up part of their gains following the auction, the last leg of this week's $104 billion new government note supply. Optimism on the seven-year note sale had mounted following strong demand on the auctions of $38 billion two-year notes and $37 billion five-year notes. In recent auctions, the seven-year maturity has been one of the top favorites for foreign investors, including central banks.
Yet the price rally in the Treasury market, resulting from a decline in U.S. stock market, had pushed bond yields down to less attractive levels for investors while deterring many dealers from adjusting their trading positions.
However, today's GDP report will be a major market catalyst as it will either confirm that an inflationary double dip has now arrived and the Fed will have no option but to print, or it will come “just better than expectations”, once again sending the market into a lithium-deprived convulsion of intraday jerkiness. Dollar lost out its safe haven edge quite prominently in the month gone by, with the US centric risk aversion making the Euro build quick strides. The GDP data would seemingly be a fitting end to a whirlwind month which is likely to push the attention right back to the US after the last few weeks was a Euro zone filled activity. For today, its looks likely that a continued flush of strong earnings and the Euro zone employment data would make the Euro try one more shot at 1.3100.
However, next month onwards, a defining activity could be seen, as a failure of the US currency to stage some pullback would be taken as serious worry about the economic conditions. If the poor economic data from US does not support the dollar in coming day's then that's probably the end of the road for the US Fed whose money printing policies are unlikely to fetch any buyers, as a melting point would have been reached. US would be just another country with a debilitating economy and a weak currency. Aka…Japan in early 1990's.