Tags: Greece | risk | ECB | Europe

Abnormality Seems to Be the New Normal

Wednesday, 04 March 2015 09:59 AM Current | Bio | Archive

While the U.S. dollar index (DXY) hit an 11-year high in early trading Wednesday, at 95.78, the spread between the 10-year U.S. Treasury note, yielding 2.12 percent, and the German 10-year bund, yielding 0.36 percent, is 177 basis points in favor of the U.S. Treasury note, the widest yield difference since May 1989. However, the U.S. economy is only performing somewhat better than the German economy is.

You don't have to be a rocket scientist to see that something illogical is at play here. This is, of course, mostly thanks the quantitative easing undertaking by the European Central Bank (ECB) that should come under full application during the coming days and of which we, hopefully, will learn more on Thursday when ECB President Mario Draghi will give his press conference after the ECB Governing Council Meeting.

It's also interesting to take notice the U.S. 2-year Treasury notes yield 0.68 percent, while their German counterparts yield a -0.21 percent, which results in a U.S. premium of 89 basis points, the highest level in eight years. Yes, abnormality seems to be the new normal.

Anyway, as strong divergences between the U.S. and the eurozone continue to rise, which is a bad omen, we should keep in mind the serious risk such situations imply, as they usually end up with a lot of collateral damages that most investors don't seem to calculate.

When we take these facts into account and we hear a lot of hype talk about investing not only in European markets, but also in emerging markets, I thought it could be helpful for the long-term investor to do a short check on a couple of risks financial markets are facing now.

Long-term investors should remember that serious geopolitical risks are still here with us, as reiterated by the speech Israeli Prime Minister Benjamin Netanyahu's gave Tuesday before Congress. These risks would directly impact the U.S. and the rest of the world should they occur.

While it doesn't seem to a majority of investors to be a prime risk, we still have the possibility of an extension of the sanctions against Russia. Already, on Tuesday President Obama extended U.S. sanctions against Russia for one year. Also on Tuesday, after a video conference between Obama and the leaders of Britain, France, Germany, Italy and the head of the European Council, they all stated there is still the possibility they'll apply much tougher sanctions on Russia if the Minsk II agreements are not applied in full, which is in my view totally improbable.

The Greek debt crisis should still be considered as a serious tail risk, although it got some respite thanks to the four-month extension of the bailout plan. But the risk remains of the country not complying with the terms of the ECB, the International Monetary Fund and the European Commission. Former ECB President Jean-Claude Trichet recently warned a Grexit, which stands for a Greek withdrawal from the eurozone and the discontinuation of the euro as the national currency, would be a big shock for the EU, while it would be an absolute drama for the people of Greece. As an investor I wouldn't underestimate the negative consequences if a Grexit would occur. By the way, Greece sold 6-month Treasury bills Wednesday morning at 2.97 percent, which is its highest yield since April 2014.

Another risk is if we see a further strengthening of the dollar combined with further weakening of commodities. That could turn out as a lethal combination for igniting the perfect storm in developing markets.

Please keep in mind, traditionally when markets get shaken by something they are not expecting the first move we've seen is gold being sold to get liquidity, which favors the dollar.

Another event that could shake the markets is if the ECB disappoints and all the ECB's talks of recent months are not backed up, even only in part, by its acts. Of course, everything remains to be seen.

Finally, the U.S. job situation on Friday will tell us further where the economy is heading. The big risk here is that if the employment numbers are too good we could cause a further strengthening of the dollar. And if, on a yearly basis, we see a further strengthening of 10 percent to 15 percent in the dollar, there is serious risk the Federal Reserve could be obliged to reassesses when to start its normalization process.

All those are tangible uncertainties.

Therefore, when you consider investing now, please "Watch your steps."

About the Author: Hans Parisis
Hans Parisis is a regular contributor to the Financial Intelligence Report. To join the Financial Intelligence Report, click here. Click Here to read more of his articles.

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When you consider investing now, please "Watch your steps."
Greece, risk, ECB, Europe
Wednesday, 04 March 2015 09:59 AM
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