U.S. stocks began the session slightly higher yesterday but quickly reversed course, along with European stock and bond markets, to close near the day’s low.  Those European markets also spent their early session a bit higher after a successful Italian 90-day auction sent yields lower (bond prices higher), for a spell.  But when the rally evaporated, yields backed up again and it adversely affected stock markets.

The euro got clocked after the latest weekly ECB report was released, showing the balance sheet continues to explode (more on this below).  EUR/USD is down to 1.29 from the 1.34 a couple of weeks back and the 1.48 back in the summer.  So this has sent the Dollar Index screaming higher and that alone will cause a stock sell off as computer-generated algorithmic trading platforms are set to sell when this occurs. 

All 10 of the major sectors lost ground for the day, led by basic material, energy and financial shares.  Consumer staples, utilities and telecoms outperformed, but they too closed lower. 

The commodity complex traded higher early, but along with stocks lost steam to close near the session’s low.  And that includes crude, which slipped back below the century market, closing at $99.52/bbl, after nearly hitting $102 in the early trade.

Well, yesterday we talked about how the Bank of Japan was blaming weak global growth on their recent economic woes.  I should mention that the Japanese economy has been stagnant for 20 years so blaming their woes on anyone else is pretty laughable.  But for whatever reason, their latest data continues to look pretty dire.  Household spending fell 3.2% in the latest month (down 13 of the past 14 months) and industrial production declined 2.6% (flat since March).

And moving on to Europe, one learns to views certain things immediately when they come in these days.  The things to watch are always changing, but what’s been a main beacon for a while is the Italian yield curve – and the focus is really on the long end, viewing to see if that yield has bounce back to 7% or to have eased back closer to 6.50%.  That’s the level to watch because many people believe that that country cannot manage around its debt problem if that cost of money.   More beyond the click.

Market Activity for December 28, 2011

Sector Activity for December 28, 2011

Well, yesterday morning was a good one as that 10-year Italian yield fell back to 6.75%, after bouncing above 7% the day before – although those gains were erased in the afternoon as that yield backed back up to 7% by the close.  What helped the price rally (yield down), albeit briefly, was a good 90-day auction that found demand at a yield of 3.25%, down from the 6.50% a month ago.  It’s clear the ECB is buying those bills in the secondary market, but helping the auction directly may have been that LTRO (the €489 billion injection) program the ECB put in place last week.  One can see banks buying this short-term paper to some extent as they borrow from the ECB at 1% (via LTRO) and buy 90-day paper at 3.25% -- that’s a nice carry.

And boy has the ECB been helping to keep the eurozone afloat, evident by its balance sheet exploding to €2.733 trillion, or $3.53 trillion, (this represents the euros they’ve printed to back up governments and the banking system).  It’s quite telling.  All of these unprecedented actions from central banks and the U.S. and euro-zone economies can merely keep from drowning. 

This morning we waited for the true test though as the Italians auction off 10-year bonds.  I don’t’ know if you can call it a success.  Sure, the yield was better than the auction last month as the auction was taken down at 6.96% vs. the 7.56% last month.  But with all of the help the ECB has extended, we’re still at that 7% handle – and as I type those bonds are back above 7% to 7.05% in the secondary market. 

Banks are just not going to be enthralled with buying such long-dated paper even if they can use it as collateral for more ECB loans.  The point is, the market gets carried away with optimism when these short-term auctions go well, but the longer-dated ones are the real test – a test that isn’t failing per se, but the yields are still to high for a stagnant economy Italian economy to manage around.  And they’ll be issuing €100 billion more debt next quarter alone.

Further, to see just how unwilling banks are to lend to one another, the ECB reports that their deposits continue to rise at an alarming rate – €452 billion was placed at the facility Tuesday night (this morning’s number isn’t out yet), that breaks the record set the night before and blows away the old record of €384 billion in June 2010 when the whole euro-zone debt issue really began to roll.  This means that banks would rather place their cash at the ECB at a negative carry (borrow from LTRO at 1% and make just 0.25% at the ECB) than take the risk of lending to one another.  That’s the ultimate signal that interbank lending remains frozen. 

So maybe banks are buying some short-term sovereign paper to offset this negative carry, but it’s pretty obvious that on the whole they remain extremely cautious.  Very telling. 

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Have a great day! 

Brent Vondera, Senior Analyst