Euro in Freefall, Volatility Picks Up

Tuesday, May 18, 2010

The euro is still in freefall hitting new lows of $1.2143 so far this evening. German Chancellor Angela Merkel announced today a ban of naked short-selling on the stocks of 10 major financial institutions and a ban of credit default swaps purchases on German government debt by speculators until March 31, 2011. This action is seemingly unneeded as the German DAX is up 0.8% year-to-date and yields on 10-year sovereign bonds are a mild 2.83%. Naked shorting of equities should be illegal to begin with; it's against regulations in the United States and many other markets. The CDS ban is on transactions by traders that do not own the underlying and therefore do not qualify as hedgers. Yet, most of the speculative CDS purchases occur in London and fall outside the jurisdiction of the German government so the ban is largely ineffective. (WSJ) The move seems very misguided and I do not see how it will help the situation in Europe, it may even cause a great deal of harm with many analysts seeing it as a sign of "desperation".

The credit card companies have been crushed in this market downturn so far. The so-called Durbin amendment, proposed by the Democratic Senator of Illinois, Richard Durbin, has investors concerned about the loss of revenue from capped debit card fees. The market's reaction seems vastly overdone with a Goldman Sachs report stating that "the financial impact of interchange legislation would be marginal for MA and V at 1-2% of earnings". Visa (V) closed down over 6% today after comments from CEO, Joe Saunders, were interpreted very negatively by the Street. Saunders believes "there may be some reduction in the volume in the short run" but does not "view the legislation as having much long-term risk for the largest U.S. debit processor" (Reuters). Visa and Mastercard have cascaded off highs 21.7% and 24.7% respectively, colossal under-performances relative to the market only 8.1% off recent highs.

The equity markets look fairly terrible with the bears solidly in control. The market closed on the lows of the day back at yesterday's lows even after the big late-day rally into positive territory seen yesterday had encouraged the bulls. The S&P futures are down another 10 handles after hours this evening. The VIX closed at 33.55% today, a strongly bearish signal as uncertainty about future prices grows. The markets have changed dramatically in short order and the bid has been removed from the market. I have some small long positions in a few US equities but I have been quickly losing on all positions. Gold has been my only successful trade as of late and I am adding on this pull-in the last couple days.

On tap tomorrow is the CPI report along with FOMC meeting minutes. Tokyo is down 1.6% already this evening looking rather dismal.

Disclosure: Long GLD.
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