Those hedge funds who found Spanish and Greek yields so delicious could be eating crow

Outlook:

Equity markets may be leading the world into risk-aversion mode and thus favoring the dollar, which already showed some signs of support—see the dollar index chart on the first page of the Chart Package. If equity markets are adopting a realistic world-view—global recession cuts corporate earnings and elicits ratings downgrades—can the Treasury and FX markets ignore it?

Sometimes it can, but it would take a stupendously good GDP report today to accomplish that. The Q3 forecast is in the range of 1.7-2.1% and centered on 1.8% (Rabobank) and 1.9% (Bloomberg survey). Traders were feeling edgy and uncertain, and ready for something to happen to drive them out of a funk. We may be getting it. US GDP at or under 1.7% could set off a cascade of risk-asset selling. 

Note that none of the FX analysis incorporates the presidential election. Polls and pundits seem to indicate it’s a tight race. We say it’s not. The public won’t vote for a guy who changes his policy positions depending on the audience—will it? Elections tend not to affect the dollar much, a tribute to the stability of the US system, but we guess traders would not like another overspending, war-mongering plutocrat, least of all one who panders to people who deny evolution and individual rights. In other words, a Romney win would be dollar-negative. If he were actually a fiscal conservative, it would be different. 

Meanwhile, the FX “should” be looking at the mountain of eurozone negatives. If it takes a stock market drop to delivery a reality check to the euro bulls, so be it, but the mountain has been growing like Topsy for a very long time and deserves more attention than the benign neglect it has been getting. This morning the German Finance Ministry spokesman told the press talks between the troika and Eurozone finance officials are still ongoing and it’s not clear the Eurogroup will be able to make any decisions at the next meeting on Nov 12. At what point do traders and investors think that kicking the can down the road had failed and the ball has met a brick wall? This endless delay is going beyond frustrating and annoying—at some point, traders and investors will throw in the towel. Those hedge funds who found Spanish and Greek yields so delicious could be eating crow.

The EMU sanity check:

• The IMF predicts a 80% probability of eurozone recession in 2013
• The WSJ estimates capital flight/deleveraging credit contraction by $2.8 trillion in assets by end-2013
• German thank-tank forecast EMU growth at -0.5% this year and +0.1% next year.
• S&P cut Spain's rating two notches to triple-B-minus, one step over junk, and Moody’s has the same rating (Baa3), also one notch over junk. Moody’s cut the ratings of half the Spanish regions.
• The EU Summit on Oct 18-19 that was supposed to resolve the Greek bailout terms did not do so.
• The EU banking supervisor will be established by year-end but may not have the authority to recapitalize the Spanish banks for another 6-12 months.