Courtesy of Everett Millman and GainesvilleCoins.com ….
ABSTRACT: Increased volatility on the markets continued as this week was full of surprises, reversals, and unpredictable currents. The Swiss National Bank’s abrupt departure in monetary policy that unpegged the Swiss franc from the euro had the greatest immediate effect on the markets, but a disquieting uncertainty now reigns supreme going forward.
GOVERNMENT & POLICY
Get Comfortable, This Is the New Normal
Understandably, in the time since the Federal Reserve completed its gradual tapering of quantitative easing purchases that grew its balance sheet, much has been made about the approaching “normalization” of monetary policy. It was equally forgivable to single out the United States as the leading candidate to be the first to make such a move. (The author must take his lumps in stride.) Alas, any declarations that the U.S. would be well-insulated from the turmoil in the international markets was premature. Perhaps not altogether wrong, but premature.
Market sentiment–and, more broadly, our very perceptions of economic reality–can change quickly, even without the catalyzing influence of despicable acts of terror or blindsiding central bank policy adjustments. The last two weeks have undeniably been shaped by unforeseen events with macrocosmic implications that transcend our (nonetheless pressing) immediate economic and political concerns. Yet, the cracks in the armor would have begun to show regardless; the rhetoric of recession would in fact be louder if our attention were not diverted so.
Even aside from the Charlie Hebdo attacks and the decoupling of the Swiss franc from the euro, souring economic measures would have shaken the rosy, post-holiday hangover from the markets’ eyes. The disappointing numbers have been diffuse across the American economy: Jobless claims climbed–wage growth receded–petroleum inventories remained in oversupply–factory output slowed–manufacturing sputtered–and consumer prices fell to a 6-year low, a sure sign of a damper on inflation. It’s no surprise that Treasury yields plummeted even further; investors can live with sub-2-percent yields so long as inflation remains largely non-existent.
What is particularly troubling about all of this isn’t necessarily the data itself. Rather, it is the reaction to the data. Sailing the stagnant waters of the world economy is tough enough; trying to do so with a boat full of delusionally cheery deckhands or, conversely, a ship of suicidal sailors jumping overboard, is an exercise in madness of another order entirely.
That’s essentially the reality we’re facing. People are either heading for the bright red EXIT sign or diving headlong into the chaos. U.S. consumer sentiment surprisingly rose (and sharply) for the first two weeks of January, as half of the market celebrates each indication that more easy-credit monetary stimulus may be in store. The central banks have pigeonholed themselves into a scenario where a large segment of the markets actually root for bad news and a sluggish economy because they know the monetary authorities will accommodate them and advance their very near-term goals. Yes, it’s true that even healthy markets operate on the principle that participants will employ opposing strategies and desire divergent outcomes, but the present level of polarization is driving volatility through the ceiling.
Sure, it’s compelling to the dispassionate observer, but only inasmuch as a runaway train is thrilling to watch pass by. When a sizeable portion of your wealth is in cargo, following the careening path of the potential trainwreck takes on a very different significance.
How Swiftly Fortunes Reverse
After an unpredictable ride last week that was made even more turbid by the terror attacks in Paris, the markets were again playing seesaw this week, and again experienced a shock on surprising midweek news out of Europe. Luckily, no lives were lost this time, and the unexpected move has likely brought a bit more clarity (albeit a painful clarity) to the near-term outlook rather than confusion.
Traders, investors, and central bankers everywhere awoke on Thursday to the news that the Swiss National Bank was abruptly abandoning its policy of pegging the Swiss franc to the euro by capping the franc against the continent’s common currency. By removing the cap, the Swiss are taking a step toward greater austerity, allowing their currency to appreciate instead of being (somewhat artificially) dragged down by a tumbling euro. This is precisely what is expected to happen when the European Central Bank moves toward purchasing the sovereign debt of EU member nations at the bank’s next policy meeting. Estimates of the size of the stimulus have been in the ballpark of €500 billion.
Prior to the policy change, analysts were nearly unanimous in their expectation that Switzerland would refrain from unleashing the Swiss franc, as it were, for at least the next year or two. The importance of the move lies in its implications for the European markets; rather than wondering if and when the ECB would officially implement purchases of fledgling government bonds, the decision by the SNB appears to be a clear signal that this proposed measure is now a certainty. The euro declined to an 11-year low against the dollar (just above $1.15), while European stock indices shot up over 2%. Such a response would seem to indicate, at least in the minds of market participants, that ECB QE is a-comin’.
Prior to the shockwaves created by the SNB, the equities markets were aimlessly trying to find their way amid the backdrop of an uncertain world economy. Tuesday morning saw U.S. indices spike, with the Dow Jones Industrial Average adding over 300 points, before Germany announced it had balanced its budget for the first time in nearly five decades. This was taken as a ringing triumph for austerity, prompting traders and investors to connect the dots about Germany’s consistent intentions to block the ECB’s pursuit of quantitative easing. The Dow cratered on the news, dropping over 100 points into the red for a dramatic 424-point intraday swing. The dollar remained strong, staying above 92.0 on the DXY spot index, despite the Japanese yen reclaiming some ground against the greenback. After sliding as low as 120 to the dollar in recent weeks, the yen bounced back to around 116 per USD.
While both the dollar and the yen are considered safe havens, the Swiss franc has long been the ultimate safe haven (among the fiat currencies, at least). Once its euro cap was removed, the franc rose rapidly to a record-high against the euro before easing up. The real beneficiaries of safe haven demand were the precious metals, which jumped to their highest levels of the new year. Silver moved back above $17/oz after falling in tandem with copper earlier in the week. (Most newly-mined silver is a byproduct of copper mining.) Palladium dramatically tanked in the second half of week, tumbling from above $815 on Wednesday’s open to $750/oz by Friday. Most analysts cited the plunge in copper prices and the wobbly global economy as the reason for palladium’s freefall, though this was the outlier among the metals.
Meantime, gold and platinum surged over $40 each on Thursday, placing both metals in the $1,270/oz price range. Not only are gold and platinum in somewhat unusually close parity with one another, but the former actually overtook the latter in early trading on Friday. This marks a 7-day string of gains for gold, which is beginning 2015 on a winning streak similar to its beginning of 2014. The yellow metal ultimately ended last year flat in terms of dollars.
It stands to reason that those worried about the shaky character of the markets would move funds into precious metals, because there’s essentially nowhere else to go in the bond markets. All of the safer bets in sovereign debt are yielding peanuts, while higher-return emerging market bonds are becoming increasingly illiquid. U.S. Treasuries keep rising, with yields on the 10-year note falling like a rock through the 1.90% threshold, all the way down to 1.75% by Friday’s open. The 30-year bond yield also hit an all-time low of just 2.39% before bouncing.
GEOPOLITICS & WORLD EVENTS
Swiss National Bank Roils the Markets
For the second time in less than three months, the Swiss central bank has moved the needle of the world markets. Last time, it was about what they didn’t do, as voters overwhelmingly rejected a proposal that would have forced the SNB to radically alter its balance sheet by adding to its gold reserves. The gold price nosedived in response, fueling a fresh rally in equities. This time around, the bank’s decision to do away with the cap on the Swiss franc relative to the euro had the opposite effect on precious metal prices, pushing gold to a 4-month high. The euro slid, vaulting gold priced in the European currency above €1,100/oz.
The policy change in Switzerland appears to be a harbinger of the European Central Bank ramping up its plans for economic stimulus, specifically the purchase of perhaps as much as 500 billion euros of government bonds from EU nations. Other central banks around the world (the ECB included) felt blighted, as Switzerland joins Germany in opting for austerity measures that are in each country’s own interest, but are at odds with the manifest calls for stimulus from the ECB and much of the rest of the Eurozone. One might charge the Swiss with being the latest player in central Europe to poop in the proverbial punch bowl.
The Swiss franc rose dramatically following the SNB’s shocking announcement, but pared its gains by the day’s end. There now seems to be little doubt, given this week’s shows of austerity from Switzerland and Germany, that the ECB will expand its stimulus plans to include sovereign debt purchases when the central bank’s governors meet next Thursday. It’s not so much the confirmation of the ECB’s impending action itself that matters: President Mario Draghi’s intentions, and the opposition thereof by the pro-austerity bloc in central Europe, have been clear from the start. The difference is that the latter is eschewing debate for concrete action, taking a firm stance that will surely inform the opposing side’s attempts to battle deflation in Europe. For better or worse, the line in the sand has been drawn boldly and unambiguously.
The butting of heads in the euro area is essentially a question of economics, yet, as is so frequently the case, this will more visibly lead to political fracturing on the continent. While the Bank of England is unlikely to join the Pan-Austrian austerity camp with inflation in the U.K. at its lowest in 15 years, the Brits have also appeared infirm in their support for stimulus in the euro area–tepid at best. With everyone watching whether or not leftist forces will wrest control of the Greek government and potentially set off a chain reaction of EU exits, the political implications of the SNB move may prove to be the first melancholy notes of the swan song for the largest economic entity in the history of humankind.
News & Notes
Gold demand is beginning to stir in China due to the approaching Lunar New Year celebration, driving up premia on gold bullion.
China has also been importing oil at a record pace since the drop in crude prices, mirroring their strategy of accumulating gold amid falling prices in 2013.
A LOOK AHEAD: All U.S. markets will be closed Monday in observance of Martin Luther King Jr. Day. Attention this week will undoubtedly shift to the ECB meeting on Thursday, January 22, when the central bank is expected to implement its own version of QE with sovereign debt purchases totaling (according to some predictions) 500 billion euros. In the U.S., housing starts and existing home sales will likely dominate the headlines in a welcome week of thin news.