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from Breakingviews:

Markets vote for the euro

By Edward Hadas The author is a Reuters Breakingviews columnist. The opinions expressed are his own. Companies are broken up when managers think the whole is worth less than the sum of the parts. Smaller enterprises are more flexible, they say, than incompatible organisations artificially joined into a single, excessively bureaucratic entity. Investors often agree and share prices commonly rise on rumours of a split. The euro is clearly different. The fear of a break-up is making the single currency fall.

The market’s vote in favour of the euro is usually portrayed as its equivalent inverse - a vote against the woes which would accompany a retrograde transition to national currencies. Yes, the euro has dropped from $1.32 to $1.25 since the beginning of May because a messy Greek exit would cause all sorts of grief, even for the stronger members. A recession would be unavoidable, just as after the bankruptcy of Lehman Brothers in 2008. Yet while that dire forecast may be justified, it is itself a tribute to the benefits of cross-border integration within the euro zone. The financial ties have are so tight that breaking them would cause a great deal of trouble.

The market’s judgment would probably be the same even if traders believed that a euro split could be managed without much additional financial stress. A currency demerger would reverse significant economies of scale. With floating exchange rates, companies will be more national and less European, cross-border capital flows will become even more capricious and Europe will look pathetic in international negotiations.

National currencies would indeed be more flexible and less bureaucratic than the euro. In practice, that means national governments would be more likely to use inflation and devaluation to avoid tackling structural economic challenges. The loss of a global currency would also be the loss of potential future gains from hosting a global reserve currency. The euro might someday replace the dollar; the deutschmark never will.

It might have been better not to have started with the single currency without more political and financial unity in Europe. But almost 14 years into the experiment, a break-up would be value-destructive. The falling price of the euro shows the market has got this one right.

from Breakingviews:

Emerging markets hit by double troubles

By Robert Cole and Jeff Glekin

The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Emerging-market investors seem to get hit by trouble near and far. They suffer when euro zone troubles erode investment confidence generally. But they also have their own particular concerns about a slowing China and an intensification of resource nationalism.

The outperformance of emerging market equities can no longer be taken for granted. Over the last three years, they have lagged developed brethren by about 8 percent. Total returns were only just positive, while developed-market stocks were up a little over 10 percent.

Slow or no-growth European economies reduce demand for emerging-market exports. If Europe’s currency breaks and its banks get crunched, demand for goods and services is almost certain to fall. Thanks to the hard-wired interconnectivity, financial stocks could be hit more directly. And financials make up a greater proportion of market values in the emerging market indexes - 24 percent versus developed markets’ 18 percent.

Now factor in conventional emerging-market worries - breakneck growth ending in a hard landing, and unpredictable governments. China is slowing, resource nationalism has flared up in Argentina. There’s even an acceptance that demand for mineral wealth won’t increase forever. Comments on May 16 from Jacques Nasser, chairman BHP Billiton, the world’s biggest miner, crystallise such fears.

India’s rupee is at an all-time low. Imports have jumped by 38 percent year on-year, driven by the higher cost of oil. There’s still no sign of a competitive exports sector beyond IT outsourcing. The current account deficit is at its highest since 1980, when the International Monetary Fund starting collecting data.

from Breakingviews:

Global sell-off could echo summer of 2011

By Ian Campbell The author is a Reuters Breakingviews columnist. The opinions expressed are his own.Global investors have been sucking money out of risk assets. Credible reassurance that Greece will stay in the euro would see risky bets poured back on. But for now Greece looks headed for the exit door and markets’ trajectory is downwards. The global sell-off in stocks, commodities and many currencies is likely to get worse as the dollar advances.

It might seem Greece is not a big enough to warrant global concern. But a Greek default would impose losses on the rest of Europe . And Greece will be seen as the first domino. Spanish and Italian bonds will be among those selling off, exacerbating financing pressures in southern Europe’s two big economies. A huge European effort would be required to calm fears that they and Portugal will not ultimately go the way of Greece.

A further concern is growth. The euro zone has stalled, China has slowed, the United States is improving, but slowly. There are strong echoes of August 2011 - a global economic “soft patch”. But this time it is coupled with far more intense fears of a meltdown in the world’s second most important currency.

The implications are likely to continue to be felt across asset classes. As the euro and many emerging economy currencies retreat, the safe-haven U.S. dollar is appreciating. That in turn unwinds the previous dollar carry trade, on which commodities, gold and many global assets had prospered.

An important difference from last summer is that the U.S Federal Reserve is not currently embarked on a programme of fresh money printing. For many assets, gold especially, that is a big negative. Gold has thrived on dollar weakness, trading speculatively rather than as a genuine haven. It now looks very vulnerable to further falls.

Unless and until European fears are calmed, the outlook for global stocks seems poor too. The lows of August of 2011 give a guide to the potential downside. They would imply a fall in the U.S. S&P 500 to 1,150, a decline of more than 11 percent on its May 15 close.

Of course, if the Greek omens change, so too will markets. But neither Greece nor investors can keep relying on bailouts. At some point and in some way the euro zone’s fundamental solvency and competitiveness problems must be resolved. Until they are, global risks will be high and markets vulnerable.

from Breakingviews:

Jewellers needed to ease gold bugs’ pain

By Kevin Allison

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Gold has a dual personality. Many think it is the ultimate hard currency. Others like it because it looks pretty. And while its price climbed high as investors have sought shelter from the financial crisis, gold has behaved more like a risk asset recently.

Despite the fresh mess in the euro zone, gold dropped to a four-month low, below $1,600 an ounce. Scared investors are moving into dollars, Treasuries and Bunds. But not gold. With the greenback’s rise against the euro keeping gold bugs on the sidelines, it may fall to physical buyers to put a floor under the price. But jewellers and other buyers who like gold “because it’s pretty” are feeling the pinch too. Especially in India and China, the world’s biggest consumers of the metal.

Political upheavals in Greece and fresh pressure on Spanish banks have pushed euro zone policymakers back into crisis mode. In recent years that sort of pressure has been positive for gold, but this time there is little evidence that it’s led to an uptick of fear-driven buying.

Asian buyers may be attracted by the lower prices. Shanghai trading picked up as the price fell below $1,600. Gold demand in India was twice the usual daily average on May 9, according to UBS. But that was helped by the lifting of a controversial excise tax on precious trinkets and the Indian government’s attempt to shore up the rupee.

More aggressive physical buying may eventually put a floor under prices. But gold’s 18 percent slide from its September 2011 peak of $1,920 an ounce needs to be seen in proper context. Years of elevated gold prices have pushed jewellery demand down by a quarter over the past decade. The metal still trades at more than double what it cost before the financial crisis kicked into high gear in 2008.

from Breakingviews:

Markets threaten no growth, no austerity Europe

By Ian Campbell

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Global equity and commodity and euro zone debt markets are at risk of a sizeable correction. French and Dutch political uncertainty and a worsening European recession will feed global concerns about growth and debt. The deepest worry is that as Europe’s economy weakens, the uncertainty about how to address the crisis only increases.

The economic data is painfully clear. The first statistics of April suggest the euro zone recession which began in the fourth quarter has extended to the second quarter and is worsening. Service activity in France contracted sharply and firms cut jobs there and in Germany. That’s bad but the euro periphery is worse, with output falling faster - in the eleventh month of decline.

The big question is what to do. France encapsulates the debate. Francois Hollande’s strong showing in the first round of the presidential election is taken as a popular endorsement of pro-growth policies. But voters are rejecting ’austerity’ when little has arrived. France’s fiscal deficit was 5.2 percent of GDP in 2011 and its public debt to GDP ratio 85.8 percent. The OECD put French government spending at 56.2 percent of GDP in 2011 - well above the whole euro zone’s 49 percent.

The periphery’s plight is worse. Although recession in Italy, Spain, Portugal and Greece is set to be deep, pleas for less austerity seem certain to be rejected by Germany. That matters, because the periphery governments need Germany’s support to stay afloat. But the periphery’s crisis is not just fiscal - it is also one of competitiveness and growth. The easiest remedy may be a messy exit from the euro.

Euro zone fears seem set to rise again. The European Central Bank has flooded banks with cash and is ill-placed to intervene in the same way, though it ought to cut rates. A modest sell off seems likely in French debt and that of The Netherlands, as it faces an autumn election. The risks for Spanish and Italian debt are much greater.

from MacroScope:

Election fever hits the markets

We’re not talking about the U.S. presidential vote, though that does cast another layer of uncertainty over the outlook. Rather, investors are focused on even shorter-horizon events, as evidenced by this jam-packed electoral worry list from Marc Chandler, currency strategist at Brown Brothers Harriman:

This weekend's first round of the French presidential election kicks of the quarter that will include:

*   Greek national elections, where polls warn that the current coalition government may not be returned, increasing the uncertainty.

*   Italian municipal elections which will be, at least in part, a referendum on Monti, who has seen his support wane since the labor reform was unveiled.

*   Two German state elections, which may see the FDP further marginalized, making a grand coalition next year more likely.

*   Irish referendum on the fiscal compact.  Due to qualified majority procedures, an Irish rejection would not prevent the adoption of the fiscal compact, but would jeopardize Irish access to the ESM, should it be needed.

*   After the second round of the French presidential election in early May, there is the parliamentary election in June.

from MacroScope:

The going gets tougher for Italy and Spain

One trillion euros is a lot of money. And as we have previously noted on this blog it did a lot for stock markets early this year but not much for the real economy.

But recent bond auctions in the euro zone suggest the impact of two rounds of cheap 3-year ECB funding on the region's struggling bond market may also be fading.

Italian three-year borrowing costs surged more than a full percentage point at an auction to 3.89 percent – its highest since mid-January.

Nick Stamenkovic, strategist at RIA Capital Markets says:

Clearly it shows investor appetite for Italian bonds even at the short end has diminished recently as the effects of the two LTROs (long-term refinancing operations) from the ECB dissipate.

That was not the only patchy bond sale recently. Italy's one-year borrowing costs doubled at a sale of short-term bills on Wednesday and, just last week, Spain had to pay dearer to borrow through medium-term bonds.

The new jitters in the market have partly been fueled by Spain's fiscal conundrum: austerity aimed at reducing its budget deficit risks choking off the very growth that is needed to repair the country’s fiscal position.

from Breakingviews:

Botched BATS IPO at least good test of markets

By Antoy Currie The author is a Reuters Breakingviews columnist. The opinions expressed are his own. The botched BATS initial public offering could be disastrous for the upstart electronic exchange. It scrapped its market debut on Friday after shares crashed from their $16 opening to just 2 cents after a “serious technical failure.” It’s a potential killer for the company, which is already the focus of investigations into high-frequency trading. The good news is that the stumble didn’t catalyze a broader market meltdown.

That at least offers some reassurance that the infrastructure of U.S. equity markets is far more robust than it was at the time of the so-called Flash Crash of May 2010. Markets tanked 9 percent in seconds then, after a few random trades kicked off a tailspin across the many electronic trading platforms and exchanges handling U.S stocks.

Friday’s flop had the latent power to create a similar fiasco. BATS accounts for some 11 percent of U.S. equity trading volume, much of it from firms using supercomputers moving in milliseconds. Instead, the damage was limited. There was the hit to Apple, the $600 billion powerhouse, whose shares were briefly halted after dipping 9 percent. The erroneous trades were swiftly nullified before the iPad maker’s stock was back up and running.

It’s a welcome sign that improved circuit breakers installed after the Flash Crash appear to be working well. That won’t, however, comfort BATS employees or investors, including the IPO’s underwriters Morgan Stanley, Citigroup and Credit Suisse.

Wall Street traders, however, can be pretty agnostic about where to send their orders. And BATS is hardly the first exchange to have technological issues - though greater scrutiny of, or even restrictions to, high-frequency trading may harm BATS more than others.

from Breakingviews:

Safe haven tremors signal big investment shift

By Ian Campbell

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Suddenly markets are shifting. The dollar is at an 11-month high against the Japanese yen. Gold has fallen by 8 percent since Feb. 28 and yields on UK gilts, German bunds and U.S Treasuries have risen sharply as expensive safe havens wobble. Global equities are up, but pensive.

All this is driven by something fundamentally good. The world economy, and the U.S. one, is improving. A third round of U.S. quantitative easing looks less likely. But a touch of normality threatens to shake the soaring edifice of safe haven bonds, scattering fallout across global forex, commodity and equity markets.

A semblance of normality is threatening because it breaks trends sustained over years and stretched to extremes: UK gilts are paying the least in three centuries, Treasuries have advanced for three decades.

Policy for exceptional crisis has brought something for everyone. QE pushed safe haven yields low in order to make money cheap for investment in riskier things – like equities and foreign currency assets. The dollar thereby became a funding currency for much else. The index of the dollar’s value against a basket of currencies peaked at about 120 in 2001 and has recorded lows in the 70s since 2008. This favoured gold, the alternative metal currency. And as commodities are priced in dollars, they too were favoured by dollar weakness.

But the dollar is rallying as Treasury yields push up. The dollar index has gone up, although it is still only at 80. The threat for inflated global commodity markets is that it keeps going higher. Commodities and gold could react very negatively. That would be a good thing. If global economic recovery is to continue – justifying the fall in safe haven bonds – oil needs to get cheaper.

from Breakingviews:

U.S. market rumblings point to revved up growth

By Agnes T. Crane The author is a Reuters Breakingviews columnist. The opinions expressed are her own.Rising oil prices and interest rates are election-year bait for U.S. politicians. But in reality – along with higher stock markets – they suggest a long-awaited strengthening of the economy. But sticker-shock at the pump and more expensive debt could yet knock confidence.

This week, even bearish bond traders seem to have conceded that growth prospects look brighter. U.S Treasury yields, which had been stuck in a narrow, low range since October, rose substantially, with the 10-year yield adding more than 0.3 percentage points to 2.35 percent before settling back a bit on Thursday. Stocks have been on a tear for more than five months, with the S&P 500 Index breaching 1,400 this week for the first time since 2008.

Meanwhile, the price of crude oil for future delivery, while not at its high for the year, is still up 39 percent from its low in October. Setting aside any worries over Iran, that’s a sign that U.S. and global activity is regaining strength, even with Europe still struggling.

Republican presidential hopefuls, reluctant to acknowledge the recovery, are zeroing in on unsavory by-products. Mitt Romney, for instance, blamed President Barack Obama’s energy policies for high prices at the gas pump. And voters do care. Paying approaching $4 a gallon with the summer driving season in sight is likely to upset American drivers. Newt Gingrich has even promised the unlikely feat of cutting gas prices to $2.50 a gallon if he is elected.

If 10-year bond yields go much higher, there’ll be at least two more lines of attack. Mortgage interest rates would rise in tandem, so homes would become less affordable for buyers and existing borrowers would get less juice out of refinancing. Even as a consequence of economic growth, that would be tough on the already battered housing sector. And second, significant increases in bond yields could signal fear of future inflation, undermining the Federal Reserve’s stance that it can keep short-term rates low with no material risk of prices spiraling.

The GOP candidates may be selective with their arguments, but higher fuel and debt costs do matter to voters, and to the economy – especially in the early, relatively fragile stages of a recovery. For his part, Obama will be hoping growth won’t trip on headwinds like these before it hits its stride.