Trading on austerity, but for how long?

Markets are betting German Chancellor Angela Merkel will stand firm on austerity measures for Europe, but our bankers know they must continue to play it safe just in case they're wrong.

On the surface it was a dull night on markets. But below the surface, market people were making two calls that represented important predictions for both the world and Australia.

The second call is particularly important for self-managed retirees with money on deposit.

The first call was that despite what the voters might want, the Germans would stand firm and there will not be a European meltdown. And so the Dow index of US shares closed above 13,000 and the German index, after being down early, gained ground.

In other words, while German Chancellor Angela Markel would make some concessions, they would amount to little more than a row of beans. Austerity would remain and Europe would face a generation of low growth and high unemployment. As I will discuss later, I am dubious about that first call, which is why the second call is important to Australia.

It's our bankers who have made the second call. I was in the company of a number of bankers last night and, while they agreed with the first call, they would not bet their banks on it.

While the overseas wholesale borrowing market for Australian banks has stabilised and money is available on better terms than those available in mid-crisis, the first call might be wrong.

And Australian banks never again want to face the crisis they faced in the global financial meltdown when the overseas wholesale money tap was turned off.

So Australian banks are going to continue to seek local deposits, which is why term deposit rates have changed little in the last week despite the big cut in official interest rates.

The banks need self-managed retiree money to effectively safeguard their position in case ‘call one‘ is wrong. And they are picking up the vibes that any further major cut in deposit rates would send that retiree money out of banks into other securities unless there was a global scare causing a dash to safety.

In a strange way the big cut in interest rates by the Reserve Bank confirmed to many Australians that we had serious problems, despite government rhetoric. This, plus the steady deposit rates, kept the deposit money rolling in and our bank insurance policy in place.

Many decades ago I can remember being at dinner with a now long-forgotten global Citibank CEO and a few tables away were a bunch of international central bankers. He confided to me that ultimately the central bankers would fail because the voters and the public would not stand for long periods of austerity. If I was a resident of Greece, Spain, Italy, or even France, and I faced a whole generation of very high youth unemployment I might be tempted say ‘to heck with it – let the banks suffer. It can’t be any worse for us’ .

The markets disagree and I could be wrong, but I am glad for Australia that our banks are playing safe.

But remember that if Europe gets into strife the Australian dollar will fall sharply. Longer term I am also an American bull (Global tremors from a US gas explosion, May 4), so that makes our dollar vulnerable on two long-term fronts (Shelter from an Aussie dollar storm, May 7).

But last night ‘call one’ helped our currency to recover ground.

I will be back with you tonight just after 8pm after the budget is handed down.

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