Fed Watch: Rumors and Threats

Tim Duy:

Rumors and Threats, by Tim Duy: From the Wall Street Journal's MarketBeat blog this morning:

“We’re now in a very sentiment-driven, rumor-driven, nonsense-driven market that’s prepared to grasp onto anything,” Dow Jones’s Katie Martin said this morning on the Markets Hub.

One of the only things holding the euro up, she said, is the so-called “announcement risk,” the fear that the eurocrats will actually pull together some kind of solution. But it’s just a hope, she said

From Bloomberg this afternoon:

U.S. stocks rose, sending the Standard & Poor’s 500 Index higher for a fourth day, after Italian Prime Minister Mario Monti said a majority of leaders at a European Union summit backed joint European bonds.

Timing is important on this one. From the Financial Times:

But summit leaders agreed such measures were months – and, in the case of eurozone bonds, years – away, and some officials have in recent days begun to express concern that the EU has not properly prepared itself for the whirlwind that could strike if a new Greek government defaults on its bailout loans and is forced out of the euro.

Most of Europe might support Eurobonds, but it isn't going to happen in the near-term. Interestingly, Monti also laid down his own gauntlet to Germany. From Bloomberg:

Italian Prime Minister Mario Monti said Germany has an interest in ensuring that no country leaves the euro.

Monti said that, in a hypothetical case, Germany would be harmed should Italy “one day leave the euro.” A weak “new lira” would put German exports at a disadvantage, though an exit from the currency region would also harm Italy, Monti said in an interview today on Italian television La7.

While “anything can happen in Greece,” the nation is likely to remain in the 17-nation currency, Monti said.

A clear escalation of the doctrine of mutually assured financial destruction - now Italy has its hand on the button. The more hands on the button, the greater the chance that someone pushes it. Meanwhile, while European politicians fiddle, Europe burns. From Reuters:

The euro zone's private sector has sunk further into the doldrums this month as new orders shrivel, forcing firms to run down backlogs and slash workforces, key business surveys showed on Thursday.

And worryingly for policymakers, a downturn that started in smaller periphery members is taking root in the core countries of Germany and France, whose tepid growth had been keeping the troubled bloc afloat.

For his part ECB President Mario Draghi is throwing down his own gaunlet:

We are living at a critical juncture in the history of the Union. The sovereign debt crisis has exposed serious weaknesses in the institutional framework; in this context, the difficulties in finding common solutions are having a negative impact on market valuations. The extraordinary measures taken by the ECB have gained us time; they have preserved the functioning of monetary policy.

But we have now reached a point where European integration, in order to survive, needs a bold leap of political imagination. It is in this sense that I have referred to the need for a “growth compact” alongside the well-known “fiscal compact”.

That sounds to me like he is saying their is not much more that the ECB can or will do. Policymakers need to get their act together. I'll see your moral hazard, and double it. See who blinks first.

Moreover, it is increasingly clear it's not just Europe anymore. Ed Harrison reiterates that this is turning into a global slowdown:

Me, I am more concerned about the global growth slowdown in emerging markets than the crisis in Europe. This is a big, big story but no one is talking about it because Europe is sucking up all of the air. It’s not only Europe here. The reality is we are seeing a global economic backdrop with nearly every major developed and developing country slowing – all with less policy space across the board. That is not bullish.

The world looks riskier with each passing day.