Fresh shocks to confidence
Investors are increasingly concerned at the lack of response from central bankers and governments as confidence across markets deepens. Fed Chief Bernanke yesterday met with President Obama to discuss the alarming situation at a time when panic was growing fuelled by ill-founded rumors of a French sovereign downgrade and a collapse in one of the nation’s leading banks. The obvious challenge facing the two is simply how to address the problem with arguably fewer tools than three years ago. The worry that few economists have addressed is that the proverbial can that is being kicked down the road is now larger, heavier and nosier. What started off as a bursting of the real-estate bubble and all its ancillary components was dealt with by a relaxation of monetary policy and a series of asset purchases designed to spur confidence across borrowers and employers. The result is that monetary policy has long been retired and the landscape has become blotted by bloated budget deficits that are missing the key growth ingredient that can heal them. We’re left revealing an ailing financial system that was veiled by what’s proved to be temporary fixes. Sliding benchmark indices are no longer flashing oversold simply because the shock to confidence in the face of government and central bank impotence is morphing into a real economic downturn. If that’s the case, equity prices have far lower to aim at before confidence can return.
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U.S. Dollar – In the short space of two weeks investors have been treated to a set of perverse price actions as events have unfolded. The biggest is probably the impact of S&P’s sovereign downgrade to the United States in an event that most would have expected to see a run on both the dollar and government bonds. The event actually crystallized rationale thoughts leading to the conclusion that the economy was set to stall and delivered a decidedly lower yield curve. So now that the economy is arguably in greater need of further quantitative easing, the Fed finds its work already done with a seismic ratcheting lower for the yield curve. Logically the dollar has followed suit. If there is to be no QE3 then dealers are more bullish on the dollar. At the same time the demand for safe havens once again includes the dollar as equity prices spiral lower. The dollar is on the verge of becoming the latest event feeding in to the loop as its rise simply speaks to elevating pressures on the financial system. Today its index added 0.4% to 75.04 and is honing in on the highest level in two weeks at 75.38. In a sign of a slowdown in global growth over the summer, the U.S. trade deficit unexpectedly widened even as a cheaper dollar in June failed to spur a slump in demand for American-made goods abroad. The deficit widened to $53.1 billion from $50.8 billion and had been expected to narrow as falling oil costs delivered a smaller import bill. Initial claims data was steady at 398,000 with fresh claims falling by just 4,000 through last weekend.
Euro – The euro slumped to its weakest in four days as policy tensions played out in the stock market where an early rally suddenly fizzled as French banking shares once again came under scrutiny. The euro recently reached its session low at $1.4103. There was also modestly good news for inflation with German wholesale prices in July repeating a 0.6% dip in the previous month with the year-on-year pace easing to 8.2%. Still, investors have savagely pared expectations of monetary tightening with the yield curve flipping over and pricing out any intention the ECB might have in raising rates in this era of elevated concern for growth. The euro pared losses after news emerged that French President Sarkozy and German Chancellor Merkel would meet next week to discuss governance of the Eurozone and other international affairs.