Europe has lost its ability to surprise

July 4, 2012

Last Friday global stock markets and the euro enjoyed their biggest one-day gains of the year. The S&P 500 jumped by 2.5 percent and the euro by 1.8 percent against the dollar. This Friday we will find out whether these moves were just a blip. Why this Friday? Because that is when the U.S. government publishes its monthly employment statistics – and these figures have more influence on global markets than anything that European leaders may or may not decide.

There are four reasons to believe this. The first is the very fact that Europe so dominates the news. Financial markets are not moved by events; they are moved by unexpected events. Once a story has appeared on newspaper front pages around the world every day for months, what are the chances that it will radically surprise? At this time last year, there was still widespread misunderstanding and complacency about the European crisis. The European Central Bank, for example, was so complacent that it was raising interest rates when it should have been cutting them. But today, investors and policymakers are obsessed with Europe’s grim prospects. A genuine surprise would have to be something much worse, or much better, than the scenarios market participants already know.

This observation leads to the second reason for shifting attention from Europe. For Europe to generate a favorable surprise that lasts for more than a few days or weeks is literally impossible. The market is too aware that for the euro to survive it has to go through a  lengthy and uncertain process of political federation. But Europe’s capacity for negative surprise is quite limited too. Everybody knows that Europe is in deep recession, that Greece will never repay its debts, that Spanish banks are insolvent, that debtor countries will all miss their budget targets and that German-imposed austerity will prolong the recession for years. The only news from Europe that would shock the markets would be a total breakup of the euro and Lehman-style financial meltdown. Such a breakup is possible, but it isn’t yet the most likely scenario. Unless a breakup happens, Europe will create lots of volatility, but the trend in financial markets will be set by events elsewhere.

Which brings us to the U.S. and the third reason to shift attention. The U.S., unlike Europe, really does have the capacity to surprise. The U.S. economy is balanced on a knife-edge. In the months ahead, the U.S. could accelerate back to the fairly robust growth it enjoyed in the fall of 2011 and winter of 2012. If this happened, it would come as a big surprise to bond markets in the U.S., Germany and Britain, which are now priced for many years of Japanese-style stagnation. Alternatively, the U.S. economy could continue to weaken, as it has since April. In that case a double-dip recession would become increasingly likely – and stock market investors everywhere would be in for a shock.

So should we expect the U.S. to produce a bullish or bearish surprise? Nobody can say for sure – and that is the final reason to expect U.S. news to drive the markets. Because the U.S. is balanced so finely between expansion and recession, every statistical release can tip expectations in a significant way. Recent experience confirms this. Since late 2010, the sustained trends in global financial markets have been driven largely by U.S. statistics, especially the monthly employment reports. The unexpectedly strong employment report of Oct. 7 last year launched the 30 percent bull market that began that week – and the end of that powerful rally in early April exactly coincided with the shockingly weak employment report published on Apr. 6, a bearish trend that was then reinforced by bad employment figures on May 4 and June 1.

In short, Europe creates a lot of noise in financial markets, but the signal comes mostly from the U.S. Why then is the opposite impression so widespread? Partly because debating European politics is much more fun than drily dissecting U.S. statistics. But mainly it’s because the euro and global stock markets tend to move in the same direction from day to day. This daily correlation, which reflects the mood swings of short-term traders between risk-aversion and risk-seeking, creates the impression that Europe is driving financial markets around the world. But on anything longer than a daily basis, the euro and the global stock markets are not correlated at all. Think back to the start of the post-Lehman recovery in global markets, on Mar. 10, 2009. Since that day, when one euro was worth $1.26, it has gone exactly nowhere, while the S&P 500 has more than doubled and the MSCI world equity index has risen by 78 percent.

So where will stock markets move next? If the employment growth announced on Friday proves better than the expected 90,000, the global equity rally will probably gain momentum. If the payrolls disappoint, the rally will quickly fade. The euro, meanwhile, will remain a hostage to the European story, whose tragic futility brings to mind the famous lament from Macbeth about human life: “It is a tale told by an idiot: full of sound and fury, signifying nothing.”


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Double, double toil and trouble;
Fire burn and caldron bubble.

Posted by TobyONottoby | Report as abusive

Nothing in this article is fact, only wishful thinking.

Posted by Klevis | Report as abusive

this article pretends to be serious but again, dear anatole, a disingenuous conflation of two different species of political economy & capitalism, USA and the EMU (european monetary union):

if generalisations must be made, then

USA – speculative capitalist (t)raiders, debt-growth based, boom and bust, thinks and acts with short-term memory; sanctions the use of war on other nations to protect its economic interests (latin america, middle east, now south-east asia), needs the communist chinese party to support the current us debt

EMU – co-operative capitalists but longer timeline to negotiate balanced outcomes, favours thrift over debt, savings and wealth accumulated over generations, prone to political risk but has wealth; needs time

the noise signal ruse in anatole’s article is nothing more than the volatility of speculative trades, hoping to profit from messages from the EMU

this is reuters motive for its gauche headline: froth the volatility and hope investors keep linking to its database

well, the LIBOR-rigging scam in london showed how confused reuters was with its noise to signal efforts over rigged rates

journalists might need EMU stories, but the EMU ain’t in a hurry

Posted by scythe | Report as abusive

I hope the stock market goes up

Posted by whyknot | Report as abusive

scythe, the last war in southeast asia was in Vietnam, from 1965 – 1974. The last war in Latin America was 1898 (if you count Cuba as Latin America – otherwise 1848).

My view is that the US is currently willing to engage in war for security interests, not economic reasons. It has not profited from the recent wars in the middle east; quite the opposite – they have been very expensive.

Posted by stevedebi | Report as abusive

Euro zone leaders have a chance to calm the bond markets and concentrate on economic reform and fiscal/political union with one simple move. Announce that Euro bonds will be introduced in 2020. This gives them a 7+ year grace period to make it all legal and confirm who’s in and who’s out. This would be a very pleasant surprise with significant impact.

Posted by changeling | Report as abusive

“At this time last year, there was still widespread misunderstanding and complacency about the European crisis.”

Most of the money is the US markets is not managed by Main Street amateurs sitting at their computers, it is managed by so-called professionals who collectively skim the cream off from the investment returns. If that more of that cream was left in the accounts and allowed to compound over the years, ordinary investors would being doing much better than they are.

IRA’s, 401’s and 403’s are set up so that even a “self directed account” allows the individual investor only enough liberty to chose which mutual funds to invest in. It’s not as though the learned professionals have been able to protect individual investors from losses.

It’s just another simple matter of corruption; the laws governing investment accounts for ordinary people guarantee that those professionals (who were complacent about the Eurozone crisis because they misunderstood it) continue to generate much higher annual incomes than the people whose retirement money they manage.

Posted by breezinthru | Report as abusive

Why should Europe surprise? Why not USA or China or Japan? Europe is out for years. It has to find its way back to sustainable recovery. At least Europe is on its way. Something what USA still has to find. Away from financial market dictations back to manufacturing and growth made by people out in the country not by Jerks at Wall Street burning one Straw fire after the other. Straw fire burns short and need instant feeding. The FED fought well. When comes the moment of truth. USA has now all asses in hand find the way back to manufacturing, lower the unemployment rate and bring families back in their homes. But this is also a model through process, not done by one moment to another. Surprise me USA.
China has to create sustainability in its society, implementing pension systems, covering the threats of the house building bubble. Can China still grow, when it starts to take care of future generations and peaceful living for elder people? Surprise me China.
When will India stop corruption and make fruitful use of its enormous potential what is hinder by bad infrastructure and corruption. When starts India to balance its society? Surprise me India….

Posted by HECConsulting | Report as abusive


me too. up and up and up and up. just like the great moderation promised. oh wait.

Posted by onlyif | Report as abusive

For my money, Keletsky has posted some worthwhile ideas, although not all his readers appear to understand what he is telling us. If I may paraphrase, “It’s the U.S., stupid, not Europe that will have the major impact on future market trends.

Moreover, Keletsky was proven correct. Friday arrived. U.S. employment figures looked bad. The markets moved big time. As Keletsky said, Europe is old news. Moreover, wherever Europe’s destiny lies, it won’t matter much in the long run. The world doesn’t turn on Europe anymore.

Posted by nikacat | Report as abusive