European Markets Could Use Some “Bad News Equals Good News” Medicine

Federal Reserve officials have become more concerned (alt) about weak growth overseas and the impact of a strengthening U.S. dollar on the domestic economy, according to minutes of the Fed’s September policy meeting…These worries…represent a new twist in the Fed’s running debate about when to raise short-term interest rates.” Furthermore, “‘it was emphasized that the Committee would need to be flexible and pragmatic during normalization, adjusting the details of its approach, if necessary, in light of changing conditions.’” All this flexible dove-talk yesterday sent the S&P 500 on a 1.7% rally, “the biggest rally this year.” At first glance, it would appear that bad news still equals good news for markets; but the momentum did not continue this morning, probably thanks to this: “German exports plunged in August…by 5.8 percent, the biggest drop since January 2009.” Economic institutes “are now expecting growth of 1.3 percent this year and 1.2 percent next, down from 1.9 and 2.0 percent previously…’The [German] economy seems to need a small miracle in September to avoid a recession in the third quarter.’” Meanwhile, “the prospect of an interest rate rise in the United States and worsening economic outlook in Germany are among the reasons for an equities sell-off that has hit newly listed stocks and curbed investor demand for [European IPOs].” Also, “Europe’s high-yield corporate bonds (alt), having been in keen demand for the past couple of years, are falling out of favor….a perfect storm of poor earnings, a large backlog of new bond deals and a weakening economic environment have partly prompted this shift in sentiment…Some investors are sticking by the asset class, pointing to continued low interest rates in Europe and the potential for stimulus measures from the European Central Bank.” Meanwhile, some bond investors say “yields are already priced for some medium-term [central bank support] over the next year. But despite recent economic strength in the U.S., we expect the Federal Reserve to be patient and cautious.” Furthermore, “any adverse market reaction to the Fed’s raising rates should be offset to some extent by the increased easing coming out of the [ECB], the Bank of Japan and the People’s Bank of China.” But here’s something else to consider: the spread between Greek and German bonds has been widening lately. “The German economy stuttering, France unable to post growth and Italy in recession…increases the odds that the [ECB] will be forced into buying sovereign debt…if that’s the case, then why the uptick in yield differential between Greece and Germany?” Meanwhile, expect the debate over “whatever it takes” to keep raging: “[ECB] President Mario Draghi said on Thursday he expects bank lending, a key impediment to growth in the euro zone at the moment, to pick up early next year.” Also, Germany isn’t backing down from austerity: “We Europeans have to become stronger, we have to deliver more growth…but it is not to be achieved by writing checks…We don’t have a recession in Germany, we have a weakening of growth,” said German Finance Minister Wolfgang Schaeuble.