SCOREBOARD: Crude celebration

Commodities and stocks rocketed on Europe's new pact, showing the immediate crisis is all about confidence.

A whole 9.4 per cent. That’s what crude jumped on Friday night after the EU’s new crisis measures were announced. It was the biggest single day gain in three years. Silver and copper then both shot up 5 per cent a piece and the Australian dollar is up 2 cents from Friday afternoon. Stocks gains were equally impressive – with the Dax up 4.3 per cent and CaC up 4.75 per cent, and Spanish stocks shot up 5.7 per cent while in Italy we saw gains of about 6.6 per cent.

You get the general picture; markets liked what Europe came up with. Now already there are those who are playing down the European plan, saying there are more questions than answers, etc – that the play is light on details, there are insufficient funds in the EFSF/ESM and the like. For mine, this analysis is based on unrealistic expectations and a misdiagnosis of the problem. The immediate crisis is one of psychology or politics even – not debt – and there is a growing circularity. Market players and commentators need to calm down and reflect on the fundamentals. But this is difficult for investors to do when they’re constantly worried about what the next guy is going to do (in response to the news). Debt for some countries is a problem, but a longer term one, as I have highlighted before.

Countries like Italy have held large debt to GDP ratios for the better part of three decades without serious consequence. Will recent decisions lead to a large immediate reduction in these debt ratios? Guarantee financing? No. But then they don’t need to. All they need to do is instil some confidence, lift sentiment – because that fundamentally is the immediate problem, not debt. Debt can be serviced in a rational market – the world has ample liquid wealth, and there are ample funds.

So then, all the Europeans need do is demonstrate that they are fully committed to the eurozone. With that in mind, the EU summit was a huge success. What some are calling a German capitulation to the periphery is in reality is a great show of solidarity and consensus decision making. Germany is clearly committed to Europe – it’s not their way or the highway. These concessions, in turn, make austerity in the periphery politically more palatable. For now then, the dissolution of the eurozone remains a pipe dream – the vain hope of die-hard euro sceptics and bankers, salivating over the enormous forex revenues a break-up would bring.

For the Australian market, the more positive European news flow reduces the likelihood that the RBA board cuts again this week. The strength of the Australian economy should eliminate the prospect of any rate cuts, but, as discussed, the RBA board ise not focussing on economic data. The board has shown extremely poor judgement in my view and unfortunately I see no reason why that would change. The best bet at this stage is to expect more rate cuts at some point. History suggest that we only need to see a modest change in the news flow, a flare up in financial market panic and the RBA board will themselves panic and cut again. Friday night’s market moves show why this is bad policy – sentiment changes rapidly in the financial markets.

Other than the Reserve Bank, Australian economic data includes house prices and TD’s inflation gauge – both at 1030 AEST. On Tuesday building approvals for May are released prior to the RBA meeting at 1130 AEST and then we also see retail sales May ( 0.2 per cent) on Wednesday and trade data on Thursday.

In the US, it’s a holiday shortened week given the Independence Day holiday on July 4. There is some solid data out though – the ISM tonight and payrolls on Friday and the headline figures, and both are expected to soften. The ISM index is forecast to dip to 52 from 53.5, while pay rolls are expected to rise only 90,000 (June data).

Adam Carr is a leading market economist. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.

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