My overall view remains the same. We will be in a economic relapse danger zone from late June through October. This is when we'll see just how far the global economy will improve after the near death euphoria has waned. I don't expect a retesting of the lows in equities, but there should be some pressure on them if this plays out. (To be fair, I've missed the last 15-20% on this up move.) We've traded 875-925 in S&P, broke above that, now 925 is the base. We tested that level a bit yesterday and held. I use equities as the barometer for risk taking/risk aversion.
In the currencies, the key question is whether any stock weakness/risk aversion brings US dollar buyers back. So far, this is not happening and that should mean a much weaker greenback going forward. One of the risk aversion themes working right now is centered on Central and Eastern Europe or CEE. The main concern now is Latvia and their recent failed government auction of debt. Today, they denied that they would be devaluing their currency. However, there overnight rates have soared to 30%.
Of course, it's not just Latvia, but all the countries on Western Europe's periphery. Austria is a country that has now entered the cross hairs due to its exposure to CEE. Reuters reports that Austria still has its triple-A rating and is on "stable" outlook. " But that could change if financial and economic turmoil in the Baltics and Eastern Europe, to which Austrian banks have large exposure, deepens."There was concern today that Austrian would have trouble with their own government bond auction, but it went well.
Tying into this theme, the IMF today called on Eurozone governments to take urgent steps to clean up the banking system as losses mount, and advised the European Central Bank to prepare "all unconventional options" in case the crisis deepens. According to the Telegraph, Dominique Strauss-Kahn said, "Stresses persist, conditions for access to bank lending are tight, funding costs remain high. Sizeable losses lie ahead as the recession unfolds. The financial sector is hamstrung in fulfilling its vital intermediation role."
Also, US Treasury Secretary Tim Geithner indicated that this weekend's G8 meeting will include a discussion on a more rigorous public stress test for European banks. The goal is to help insure that these institutions survive if the economy slips from bad to worse according to the WSJ. Last month, European bank regulators said they would complete tests on their banking systems by September.
Clearly, the CEE situation is worsening and making many nervous over the domino effect it could generate towards larger Eastern European countries. Remember, there was a rumor that the ECB was going to announce buying local country bonds prior to the meeting where they provided a plan for covered bond purchases. This would've stabilized the situation for Hungary, Poland, and perhaps the Baltic states. This didn't happen and Latvia fails on their auction.
The good news is that the IMF is ready to lend if Latvia follows their guidelines of reducing government spending. So far, Latvia looks ready to cut state spending and receive its next tranche of bailout cash. However, any additional failures will dent/impair the Euro rally as risk aversion will return with uncertainty over the fallout. This situation will get additional newsflow heading into the weekend with the G8 meeting in Italy.
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