Creeping political paralysis

Creeping political paralysis
09/05/12 @ 07:00 GMT by Simon Smith, Chief Economist

The implications of events in both France, and more so Greece, are seeping through markets and have made themselves known within most asset classes. In FX, it’s created further pressure on the high-beta currencies, with AUD/USD nudging very close to parity in overnight trading. The Kiwi and Mexican peso are also notably softer. On commodities, gold has pushed below the USD 1,600 level, down 2% yesterday and, significantly, breaking below the long-term uptrend line drawn from the November 2008 lows. Core bond yields were also squeezed ever lower, with 10yr UK yields at 1.94% - just above the lows for the year. Meanwhile, German yields were once again reaching multi-year lows just above the 1.50% level. The upshot is that we are undoubtedly entering a new period of political uncertainty and stress in Europe, something which we’ve seen before but, more than ever, the ability of markets to shake it off will be severely tested.

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Commentary

Fiscal austerity looms down under. Facing an electoral whitewash when it next goes to the polls, Australia’s Labour Government has opted for aggressive fiscal austerity in its latest budget in an attempt to claw back its reputation for financial responsibility and competence. Treasurer Swan threw around some very impressive-sounding fiscal figures in his budget speech yesterday – AUD 33.6bn of spending cuts over five years, a first annual decline in government spending for 42 years in fiscal 2012/13 and a return to a budget surplus next year after a AUD 44bn deficit in 2011/12. Quite correctly, Swan contends that tightening fiscal policy in this way will provide further room for the RBA to ease monetary policy. Together with last night’s poor news on the trade side, the ammunition for another rate cut from Australia’s central bank is already mounting just a week after it chopped the cash rate by 50bp. As a former leading politician suggested last week, the RBA could lower the target cash rate to just 2% before too long. For the Aussie, those fundamental positives such as decent global and local growth expectations and respectable interest rate differentials which underpinned the currency for so long are now unravelling quite quickly.

Sterling’s ongoing resilience. We’ve remarked before on the resilience of sterling and this has again been in evidence over the past week; of the majors it was only the yen outperforming the pound as of yesterday. This comes despite the weakness seen in the UK’s PMI data and also the earlier confirmation of the recession in light of the negative growth outturn in the first quarter. Sterling’s relatively good performance can be put down to three things. First, it has benefitted from diversification flows from the euro as investors have looked to hedge against a downturn in sentiment. Second, the pound has not been subject to the same sovereign pressures as other nations, given that it embarked down the austerity road a lot earlier than most. For now, sterling still retains a triple-A rating from the major agencies. Finally, the BoE has the scope to be more responsive to the crisis than the ECB and recently expanded its QE program to support the economy. In general, such efforts have been less negative for the currency than was the case in the early days of the global monetary response. As the eurozone looks to be headed for another round of political in-fighting, and the ECB stands its ground, these themes are likely remain strong in the coming weeks.

Greece again. It had almost reached the stage at which the markets could go several days without thinking about Greece, which is in marked contrast to a couple of months ago. The leader of Syriza, the second biggest party, has told those entering coalition negotiations with them to renounce support for the current EU support packages. This is clearly a de-stabilising development and in part explains the broad risk-off move we’ve seen in markets. We await to hear of the success or otherwise of these negotiations, but there’s a decent chance that we may have another election in the coming weeks if the negotiations fail to lead to the formation of a new government. If this proves to be the case, then we can expect to see EU leaders and the IMF once again put any further tranches of bail-out money for Greece on hold. This change in mood is already being felt in markets. We’re seeing German yields squeezed ever lower, stocks sagging and gold softer as well. For now, it appears as if the honeymoon is over for Greece’s brief move into relative obscurity.