Capital Markets Update

By Louis S. Barnes Friday, August 5th, 2011

While you were watching the Debt Limit Channel, the world was tending other business. Not very well. Bottom line here, USA: we are not double-dipping, not yet. Very little forward momentum, the weakest numbers since 2009, but still moving.

The violent movements in markets are directly traceable to Europe, not to new US recession or to debt limit action. We have a workable budget deal. The opposing parties are back in their dead-end corners, where for the time being neither will do any harm: the Right in pursuit of a balanced-budget amendment, the Left searching for its cheese.

The July ISM manufacturing survey arrived at 50.9 versus 55.3 in June and 54.0 expected. The “prices-paid” sub-component has collapsed from 85.5 in April to 59.0 in July. The ISM service-sector slid also, to 52.7 from 53.7, but any value above 50 signifies growth. Consumer spending in June went negative .2%, income rising only .1%. The July payroll report this morning could have been a lot worse, up 117,000 jobs, but should not be confused with “good.”

Correlation is not cause, but… Europe’s newest debt/currency fix was announced on July 21, a Thursday. Markets traded happily that day. Before Friday was over, the modified European Financial Stability Facility was exposed as a pathetic self-deception, the weak to levitate themsleves, Germany to avoid any meaningful commitment to the others. Beginning the following Monday, July 25, and since: the spread between German 10-year bonds and Spanish and Italian ones has opened 140bps (today, GER 10s yield 2.30%, SPN 6.06%, ITL 6.16%). French bonds have begun to open, too.

Two traditional markers of European panic: gold, up another forty bucks from an already wild high to $1,663/oz; and the Swiss franc, $0.94 one year ago, $1.22 on July 25, $1.32 today. The euro itself is holding $1.42 in dynamic tension: if the zone collapses on Germany, Holland, Austria, and Finland, it will rocket toward two bucks, a new hard-currency safe-haven, a big Switzerland. If Germany concedes, the ECB to print cash to buy Club Med bonds en masse, the euro will collapse below one buck.

Since July 25, the S&P500 has departed 1,344 and a six-month trading range near there to 1,182 today. A 12% loss, straight line. The inflation yahoos have lost again, just dead wrong for five-straight years: oil is often a panic-proxy for gold, but has dumped to $85/bbl; natural gas from $4.50 to $4, copper from $4.40 to $4.10.

The US 10-year note traded at 3.00% on July 25 and touched 2.41% yesterday, despite the utterly disgraceful efforts of the Left, screeching “Default!” to protect its cheese; the brinkmanship of the Right; the meddlesome incompetence of the rating agencies; and media that won’t even try to get these stories right. Part of the drop in the 10-year is temporary short-covering (see “inflation yahoos,” above); mortgage refinancing locks under 4.50% will tend to insert a floor; and today’s levels touch strong technical resistance to further declines, set last October. Bottom here.

Looking forward, which is what matters, European chaos makes it easy for us to sell new Treasurys, and we have lots to sell. $75 billion in new long-term ones next week alone, about that every 20 days ahead for at least the next two years. A complete euro-collapse, which seems inevitable, would greatly if temporarily slow their economy, and create new global bank losses, but contagion here is hard to identify. S&P500 earnings are roughly 65% overseas, hence the stock market’s extreme reaction since July 25. However, after a euro-collapse, you’d hear a lot less about the need to diversify away from the dollar.

Somebody here may note the failure of European political and leadership, and begin a discussion here. The center of European failure, of course, is self-deception — a relentless refusal to modify hypothesis in the face of contrary evidence.

Here the failure is different: we are in a policy free-for-all and leadership vacuum. Without the prior experience of a time like this, we cannot distinguish wisdom from wise-guy, fanatic from frivolous, sensible from suicidal. Tabula rasa in terra incognito.

Europe is buying time for us.