Markets are weak but not enough to expect central bank action

Risk-off continues and commodities and cyclical stocks are getting whipped. Gold is even taking a beating. So where are markets really and why? Here are my observations.

Country risk on the rise
The mess in Greece has really put a spanner in the works. Greece is still not a huge problem when compared to Spain, but the new political instability and increased concerns about a Eurozone exit requires attention. It is sending strong risk warning signals to investors - stronger than what would normally be the case. Country risk is rising as investors are no longer able to view the Eurozone as one entity. Instead they need to take the situations in individual countries into consideration.

Central banks are not ready to fire
The European Central Bank is unable to do much at the moment to provide relief. The situation is not dramatic - yet. So no trigger for more Long-Term Refinancing Operations from ECB Chairman Draghi. Furthermore, investors probably need to carefully consider leverage rather than liquidity. For more views on this see: European Banks leverage is not the issue. Even central banks are not able to help, as asset sale is not their route.

Looking at the US then, Federal Reserve Chairman Bernanke and the Fed is in a situation where it is happy that yields are falling again. But this has come about due to weaker macro data and higher risk. Stocks are down but not by much, and financials are not tanking either. There is less of a need for a Bernanke put. Thus investors are unable to discount another quantitative easing round and as such this creates a sense of limbo.

Investors have become used to artificial help to create gains. The markets are weak but not weak enough for central banks to react. From Chart 1 it seems that the S&P500 is directing the sense of urgency from the Fed. Sorry to say, oil and gold, that the S&P500 is not weak enough!

Asset signals
Combined, all these factors have unnerved investors and resulted in some even pulling the plug. It has put pressure on some of the biggest beneficiaries of QE: Gold and Oil.

When are gold and oil hip again? I would expect an accelerating drop in the S&P500 followed by speeches or interviews with Fed members where new measures are discussed or hinted at. Until then I expect gold and oil to trade to the heavy side.

In the meantime while we wait and listen to useless rhetoric from Greece and experience limbo in other assets then it is my opinion that EURUSD will weaken further. It is just a matter of time, partly because the yield spread almost always creates an investment flow towards the US and this has not changed, see chart 1.