Major News This Week: January 15, 2013

Last week produced many newsworthy items from outside North America. First, at a news conference on Thursday, Mario Draghi, the President of the European Central Bank, declared that the eurozone should slowly recover in 2013 following three sluggish years.

This positive message allowed the euro to post its best daily price fluctuation in six months, jumping 1.6%. That same day, China announced record export growth of 14.1% (YoY). On Friday, Shinzo Abe, the Prime Minister of Japan announced a $116 billion stimulus plan that should help fuel exports by weakening the yen.

“Since becoming a central banker, I have learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said.” - Allan Greenspan

The euro advanced last week following comments made by Mario Draghi, the President of the European Central Bank (ECB). He mentioned that, from a financial viewpoint, the situation had returned to normal, even though the economic recovery was still weak. This observation was based on lower sovereign bond yields, reduced demand for credit default swaps (CDS) in Europe, a stronger balance sheet at the ECB and generally lower market volatility.

These elements demonstrate investors’ more favourable outlook that Europe’s reforms will succeed. For example, in January 2012 investors believed that there was a 49% chance that Greece would leave the euro within 12 months, but the probability for this has since fallen to 15%.

However, not all the problems have disappeared. As expressed by Jean-Claude Juncker, Prime Minister of Luxembourg, “The worst is over, but what we still have to do is difficult.”
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This change of sentiment is important and significant. The behavior of the USD since the beginning of the year has been a visible precursor of this change. Recently the USD has tended to appreciate when good economic news was released in the U.S. This is the opposite of what we saw in 2012, when any good economic news was perceived as signaling an environment favouring risk assets and, therefore, bad for the USD.

If the market now believes that we have avoided a financial catastrophe, it will return to normal and respond more to the differences between regional economic outlooks. But is the worst-case scenario reply behind us, or are we, once again, being overly optimistic?

This new outlook of the financial environment will be sorely tested when Europe continues to be the source of much bad news over the coming months. We can also expect other issues to worry markets, given that elected officials in the U.S. will once again be trying to find a solution to their fiscal problems.

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