Following weeks of low volumes, slow news flow and steady gains for equity markets investors are braced for some big events in September which could make or break investor returns for 2012.
The last trading day of August is highly anticipated with Ben Bernanke set to make a key note speech at the annual Jackson Hole meeting of central bankers. In 2010 Bernanke used the speech to let investors know a second round of (QE2) was on its way. Investors are now questioning whether he will follow suit in 2012 by indicating QE3 is just around the corner and the debate in the U.S. appears to have move from if, to when.
“We fear that the pain threshold needed to trigger stimulus in the decisive phase of the election campaign has not been reached yet,” said Jan Poser, the chief economist at Bank Sarasin in a research note ahead of the speech.
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The highly anticipated speech could see Bernanke outline the options at his disposal without indicating which option he will use and when according to Poser.
“All we are expecting from the Fed’s meeting on 12 September is an extension of the forward guidance of low interest rates—from 2014 to 2015,” said Poser, who thinks it will take a bigger slowdown in U.S. employment (CNBC Explains: ) and manufacturing for the Fed to act, probably during the fourth quarter.
Others agree that the Fed might not be ready to act just, yet but think if it does, riskier assets will do well going into year end.
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“The Fed is likely to compensate for the fiscal risks to U.S. growth through additional monetary stimulus measures, particularly if employment remains weak—another round of quantitative easing could at least provide some underpin for equity markets, and the economy by weakening the dollar ,” said Herman van Papendorp from the strategy team at Renaissance Capital.
Papendorp believes there is unlikely to be a major sell-off in Treasuries in the coming months despite such low returns in high quality government debt.
“By buying into these assets at current negligible yields, we think investors are likely to reap negative real returns in the medium to longer term as global policy makers have an overriding common goal of reflating their economies,” said Papendorp in a research note.
With stocks having had such a good run, Papendorp believes the market is moderately overbought with the low level of the VIX pointing to possible downside risks if the economy deteriorates significantly, unless of course the Fed intervenes.
If the decisions facing holders of U.S. assets are tough and driven by the Fed, then for investors in Europe September is likely to be even more difficult to call. With a decision on what to do next with Greece kicked into October when a detailed report is expected on Athens’ compliance with its bailout is due. But the first event to worry about is the September 6th meeting of the European Central Bank (CNBC Explains: ) amid reports it will step in to buy government bonds or set some kind of trading band on Spanish and Italian borrowing costs.
“We fear that a consensus on this is not possible, nor do we think that this measure would be useful. There is a substantial risk that a lion’s share of the total volume of outstanding peripheral bonds would be tendered. The most probable scenario is that the ECB will consider sporadic purchases of short-dated bonds of certain countries, when these governments need to borrow funds on the capital markets,” said Sarasin’s Poser. To go further:
Poser believes the stumbling block will be Italy and Spain’s refusal to accept the conditions which come with asking the EU for assistance, something which will limit the ECB’s ability to help.
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“[The ECB] will only do so if the country in question has placed itself under the protection and scrutiny of the European Stability Mechanism (ESM) and has satisfied the relevant terms and conditions. The ball is back in Spain and Italy’s court”
On September 12th the German constitutional court will rule on whether use of the ESM is compatible with German law. Poser believes ESM will pass but not until the court makes it clear the limits of Germany’s Basic Law have been reached.
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The court ruling is also likely to further harden opinion against the use of German tax euros being transferred to peripheral euro zone members leading to a hardening of rhetoric from all parties as we approach .
On the same day, the Dutch go to the polls with attitudes to Europe and the euro zone hardening in that country. The socialist party is ahead in most polls but will be forced to deal with the reality of its economic position if it forms the next government despite its anti-austerity rhetoric ahead of the vote.
“The ambivalence of the Dutch towards Europe will increase, which will fuel uncertainty over euro politicians’ resolve,” said Poser. Others though believe the election will change nothing with whoever wins forced to deal with reality.
“Since all parties are aware that budget consolidation is necessary, we expect that the new government will continue to reduce the deficit this year and next,” said Commerzbank economists in a recent research report.
Once the Dutch election is out of the way finance ministers and officials will head to the small island state of Cyprus for a weekend of talks likely to be dominated by what to do with Spain, and by extension Italy.
If ECB assistance is dependent on euro zone members formally asking for EU and even IMF support, then Madrid and Rome will come under pressure to put their pride to one side and accept help, with conditions on spending.
“Our hope is that the ECB’s rescue plan will be well received by the governments of Spain and Italy, with the result that these countries accept the protection of the rescue umbrella when the Eurogroup meets on 14 September, thus reducing the Greek contagion risk,” said Poser.
This will prove very difficult for Mariano Rajoy’s government in Madrid and Mario Monti’s technocrat government in Rome and will need Mario Draghi, Angela Merkel and maybe even French President Francois Hollande to offer lots of carrots to make up for the use of a very big stick in the eye of Spanish and Italian voters.
“That said, we do not think these two countries will place themselves under the protection of the bailout fund, if it is not absolutely necessary,” said Poser.