Macro Commentary: Risk-on/Risk-off - Welcome To Dyslexic Friday

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From Brian Rogers of Fator Securities

Macro Commentary:  Risk-on/Risk-off - Welcome to Dyslexic Friday

Markets are currently rallying in reaction to the short-sale bans enacted in Europe.  Time will tell if these bans ultimately prove effective seeing as how when the US banned the short-selling of financials in 2008, they proceed to collapse over the next few months.  Investors are usually correct in estimating that a trading ban is nothing more than formal confirmation that there is indeed a problem.  With banks borrowing more from the ECB in recent days and less from each other, we have yet another sign that European banks are getting nervous of each other’s risk.  But at least for today, equities are solidly in the green. 

Despite the positive reaction in stocks today, the economic data out of Europe this morning was ugly as European industrial production fell and France posted below consensus GDP numbers.  The concern with the French numbers is that it will impair the French’s ability to maintain their cost-cutting efforts which are key to maintaining their AAA.  If France were to lose its AAA, the ESFS would be imperiled as would Europe’s efforts to avoid haircuts on PIIGS debt.  Data in the US was better than expected with retail sales coming in slightly above expectations and higher m-o-m.  All-in-all, chalk this Friday up to risk-on.  However, given the price action lately, that could change to risk-off with a single headline, we’ll see how U. of Michigan Confidence and Business Inventories look.

The political season is gearing up in the US with Republican Presidential hopefuls holding a debate in Iowa in front of Saturday’s critical straw poll which is a critical gauge of a candidate’s viability at this stage in the game.  Mitt Romney appears to have been the winner or at least the candidate that looked the least bad although he has played down the Iowa results and thus has lower expectations about his performance.  Besides Ron Paul, who probably doesn’t have a realistic chance of winning the Republican nomination given his stance on cutting defense, ending the Fed, legalizing marijuana and any number of other issues the Repuliban party takes issue with, Romney seems to be the only candidate with the bona fides to successfully attack Obama on the economy. 

However, I remain of the opinion that the election in 2012 will hinge on what the Tea Party does.  If the Tea Party decides to run a candidate, any candidate, it’s likely the Republicans will lose and Obama will win.  Why?  Simple math.  The Democrats will typically end up with about 38% of registered voters while the Republicans will get somewhere in the neighborhood of 32%.  Independents, Libertarians and others will make up the other roughly 30%.  Any Tea Party candidate will naturally pull more votes away from the Republican candidate than the Democratic candidate.  Unless the Republican candidate can dominate the independent vote, something that is certainly possible, but not likely given historical trends, Obama will win even though he probably doesn’t deserve it.  But if the election trend of 2010 carries into 2012 and the Republicans are able to take the Senate, we will find ourselves in the situation that most Americans seem to favor, one party leading Congress, the other party in the White House.  So what will the Tea Party do?  Until we know the answer to that question, we won’t know who really has a chance of winning in 2012.  Does this mean that Rick Santelli, philosophical founder of the Tea Party, is the new kingmaker in DC?

One final thought on this green screen Friday, lots of chatter going around about the Swiss potentially pegging the CHF to the EUR, even if only temporarily.  Given the difficulties the Swiss would have implementing such a policy as it would likely require a change in their constitution, it seems unlikely to me that this will happen.  However, it provides a window into the extreme pain being felt in Switzerland.  It’s not easy being the world’s strongest fiat currency.  Unfortunately for the Swiss, with ZIRP going on until at least 2013, the pressure isn’t about to go away any time soon.  And obviously, the Swiss aren’t the only ones suffering from a strong currency – the Brazilians, South Koreans, Chileans, Australians and Japanese are also suffering as their exporters bleed cash.  How long before we see real capital controls from one of these countries?  It can’t be too far off now.  How long can Japanese exporters, which don’t make much money with the JPY at 90, stay in business with the JPY at 76?  Some of these countries can lower interest rates (Brazil) but doing so risks stoking domestic inflation, already running at uncomfortable high levels.  Central bank interventions have stopped working as the half-life of success is now measured in hours before the market overwhelms the move.  Raising taxes and fees can have some effect, but when you’re getting a negative real return in the US and a positive real return somewhere else, even allowing for the taxes and fees, then the choice is easy.  So the investment flows will continue.  And the strong and/or high yielding currencies will keep appreciating.  Until governments take more extreme measures to stop them.  Which they will be forced to do eventually.  The only questions are when and how.  Have a great Friday!  -Brian

Addendum: U. of Michigan Confidence numbers just came out and they were a disaster (54.9 actual vs. 62.0 expected).  Worst number since May of 1980.  Market is moving lower on the data.  Risk off.  But stick around another 15 minutes or so, that could change…

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