“ The Economy, stupid†was a sign hung in Bill Clinton’s campaign headquarters to keep everybody “on message” in 1992. It was originally meant as an internal motivator, but it soon became a famous centre point for Bill Clinton’s victory against George Bush Snr. At the time Bush was accused of neglecting the domestic economy as the US went through a recession from 1988 to 1992.
The US economy is once again centre stage for all the wrong reasons, and people are increasingly speculating about the odds of the US dipping into negative growth, in other words… a recession.
Various media and financial commentators are pitching their estimates for the probability of a recession. Even former Fed chairman Alan Greenspan has put the odds as being between a third and a half. However, the emphasis so far has been on slower growth rather than negative output.
Sentiment is increasingly focused on the actions of the Federal Reserve or more accurately, the market’s confidence in Fed Chairman Ben Bernake. Last week the minutes from their last meeting revealed they were reluctant to cut rates in the face of rising inflation. However, fed futures are currently pricing in a 65% chance of a cut in the December meeting. Many analysts believe that the Fed may soon have no choice but to act.
Over in the UK, MPC meeting minutes revealed that members had voted 7-2 in favour of keeping rates on hold, as expected. The chances of a rate cut in December increased on Friday, as Deputy Governor Rachel Lomax went on record as saying that the bank needed to be “very alert to the risk that the economy
may be slowing too abruptly. At current interest rate levels, monetary policy may well be on the restrictive side”. Despite this, a ‘no change’ verdict is still the most likely option at the December meeting.
The Eurozone credit markets saw widening spreads between German Bunds and bonds from countries such as Italy and Greece. This flight to quality occurred as credit market liquidity once again froze on Thursday, with the US markets being closed for Thanksgiving. The Euro saw dramatic movements at end the week. The EUR/ USD exchange rate came within 32 pips of 1.50, but slumped dramatically to just above 1.48 in
later trading. Talk of ECB action to counter the effect of a strong Euro was behind some of the fall.
Next week is dominated by housing sales data, with UK house prices released on Monday, US existing home sales on Wednesday and New home sales on Thursday. With much of the bad news already in the market, it will be a case of how bad the news actually is that governs reactions to this data next week. Other first tier announcements include US consumer confidence GDP figures.
Before Friday’s recovery, November was looking at being one of the worst months on record for the FTSE. This November in particular has been the worse since 2000 for the S&P 500, and at the time of writing was showing the fifth worse intra month decline of all Novembers on record. After such large moves, it is not uncommon for the market’s spring to recoil.
The recent volatility has pushed up the premiums available with trades betting against further large movements. This presents a potential opportunity. After such large moves in November, the S&P 500 has a tendency to be positive in December, although the movements are extremely choppy. Between now and the New Year, there is the distinct possibility that markets could grind rather than crunch, making a barrier range trade seem attractive. It’s the economy, stupid but the stock market may just be able to stave off the feared all out collapse until 2008.
A barrier range trade on the S&P 500 with the expiry set as the 3rd of January 08 and the barriers set as 1233 and 1628, returns 12%. This provides roughly 200 points protection either side of the current market levels. This represents the maximum range allowable by BOM for the time period. This puts the barriers well beyond the highs and lows for the year.
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