by Shawn Narancich, CFA
Vice President of Research
In China, Sell on the Rumor and Sell on the News Investors got what they were waiting for in China this week, as the central bank there took the next step to halt the country’s weakening economy with an interest rate cut The reaction in Chinese stocks? They fell on the day prior and on the day after the move by the People’s Bank of China. While Chinese stocks remain underwater year-to-date on concerns about slowing growth and lack of a “shock & awe” stimulus program like China instituted during the financial crisis several years ago, U.S. stocks rebounded nearly 4 percent in what turned out to be one of the strongest weekly gains of the year. As investors ventured back into domestic equities, the benchmark 10-year Treasury yield went up, ending the week at 1.63 percent.
Monetary Policy to the Rescue? If U.S. equities weren’t as oversold as they were coming into the week, the result might have been different. Investors were left wanting with a lack of actionable announcements by both the U.S. Federal Reserve and the European Central Bank. Europe left its 1 percent short-term interest rate target unchanged, and Fed Chairman Bernanke failed to tip his hand to Congress about what, if any, new monetary stimulus it might offer to rejuvenate a weaker economy. With political leaders on both sides of the Atlantic far from agreement on how to address their respective fiscal challenges, investors continue to look to monetary policy as the antibiotic to stave off infection. The problem is that, with each additional dose, the infection becomes more resistant to the treatment. To conclude the analogy, surgeons general in both Europe and the U.S. have told patients that they stand ready to provide additional treatment, if necessary.
The Next Domino to Fall in Europe Central bankers will most likely get that chance, as sovereign debt yields in Spain remain above an unsustainable 6 percent level, indicating that it’s only a matter of time before this country seeks financial assistance. European finance ministers will meet tomorrow and plan to discuss the mechanics of a Spanish bailout. For its part, Spain is awaiting a key report from the International Monetary Fund that purports to show the additional capital that its banks need to remain solvent. With German Prime Minister Merkel warming to the idea of pan-euro bonds and common EU deposit insurance at some point, European leaders appear closer to embracing the necessary fiscal integration in concept. Unfortunately, no nation there yet seems willing to cede budgetary and banking oversight to a central EU authority.
A Catalyst Rich Calendar Which brings us back to Bernanke & Co. Recognizing the challenges of Europe and the looming fiscal cliff domestically, the Fed could do a QE3 but likely wants to keep its options closer to the vest for now. Results of a potential Spanish bailout, Greek elections on June 17, and additional domestic data will all bear on their decision to be made at their meeting on June 19 and 20. A key question domestically is whether recent soft payroll gains reflect payback for a record warm winter or something more sinister. Reality is probably somewhere in-between.
In a week dominated by macroeconomic policy events, Australia cut rates by another quarter of one–percent, and emerging Asian economy Vietnam cut rates by two percentage points as central bankers in the Asia Pacific attempt to fend off slower export markets to China and Europe.
Our Takeaways from the Week
- U.S. stocks rallied from oversold levels as investors continue to closely monitor events unfolding in Europe and potentially systemic contagion therein