Money: All dressed up and nowhere to go

by David Taylor

As is usually the case on the global financial markets’ stage, something unique (but reflective of a much broader picture) can spark a selling frenzy. Last week it was the cry for help from one of Spain’s largest banks – Bankia. A chain of events coincided with that, and led to an enormous flight of capital (money) to the United States. But isn’t the United States also in trouble, you ask? Good question. The answer is, yes. Friday’s unemployment reading has confirmed that. So where else is there to go? Another good question. Well… I guess, gold?… maybe?? It’s all a bit pathetic really.

Let’s take a closer look at what’s going on, shall we?

I’ve thankfully never been told I have a serious illness. I imagine it would be pretty hard to take. Once the initial shock had passed, I imagine you would start to get used to it. That is until someone reminds you of it again or you’re repeatedly told by the doctor that it’s getting worse. That’s precisely what’s happening in Europe at the moment. The disease is debt, and the euro zone is riddled by it. Every once in a while though something happens that reminds the world just how bad the problem is. The middle of last week saw a chain of events that really spooked the market.

First, news that the European Commission (EC) had sided, or felt ‘sympathy’, for the failed Spanish bank – Bankia, so went to the European Central Bank to ask – very politely – for some money in an attempt to re-capitalise the bank. It was hoping the ECB would dip into the European Financial Stability Facility (bloody great big bailout fund) to rescue the bank. The answer was ‘no’. Financial markets didn’t like that -nor did Bankia investors - sending the stock down around 28 per cent.

That same day, we also saw anti-austerity parties in Greece move ahead in the polls. The bottom line is that if Greece doesn’t undertake major reform it will be booted out of the euro zone. That would certainly send markets into a tailspin.

Completing the perfect storm was more data confirming China’s economy is slowing a little bit faster than market watchers are comfortable with. That was capped off on Friday with China’s official read on manufacturing activity. The PMI came in at 50.4. A level below 50 signals the sector is slowing at an alarming rate. You could make yourself feel more comfortable by saying, ‘it’s ok, the Chinese authorities have plenty of tricks up their sleeves to stimulate their economy’ – and you would be right! The sting though came from BHP Billiton this week when CEO, Marius Kloppers, told investors Australia’s biggest miner was putting a stop to any major new investments until at least the 15thof December. That puts the multi-billion expansion of the Olympic Dam mine in doubt and tells markets the board is no longer as confident as it used to be about on-going demand from China. That speaks volumes.

So, in the wake of a storm, what does money do when it’s all dressed up with nowhere to go? It makes the best of a bad situation and settles in the United States – specifically US Treasuries. Towards the end of last week the demand for US 10 Year Treasury notes reached a record high (prices soared). It pushed the yield (or return) on those bonds to just 1.5 per cent. Similar levels were achieved back in the middle of last century. A strategist from Deutsche Bank told me last week it meant financial markets were now pricing in another global recession.

The response from many people when you tell them that the United States has been a magnet for money this week is one of confusion. Isn’t the US also kinda messed up financially? If you take last Friday’s employment data you would have to say it’s at least looking that way. The unemployment rate in May actually edged up to 8.2 per cent. It’s certainly not a good sign that unemployment is going in the wrong direction, but what really spooked markets was that only around half of the jobs that were expected to be created actually came through. It made many international investors second guess just how solid the US economy actually is. Naturally, in response, the price of oil fell (the US is one of the largest consumers of the stuff), and gold (the only other major credible alternative to US Treasuries) rose.

Things are getting serious again. Still, there remain both optimists and pessimists out there. There are some who believe an 11thhour resolution will be achieved to solve the euro debt crisis and pro-austerity parties in Greece will be elected into government – and all will be right with the world. There are also others though who anticipate it will get worse before it gets better.

The Australian dollar is only a tiny currency on the world stage, but it also happens to be one of the most actively traded in the world (especially the AUD/USD cross rate). It’ also one of the finest barometers you’ll find for tracking the psychology of global markets. Last week it fell to its lowest level in 8 months. Investors are voting with their feet. They’re moving out of all kinds of risky assets and into the safest one’s they can find.

This simply isn’t the time to be taking any risks. That tells you everything.

David Taylor


The content in my blog is non advisory, please do not interpret this as advice in any way shape or form. These are just my thoughts and nothing I say should be acted upon.

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