Risk On Despite Big Drop in New Home Sales

Posted on

It is nice to finally be able to say that we have a risk on day. Safe haven flows eased out of the U.S dollar and Japanese Yen despite much better than expected Japanese trade numbers. U.S. new home sales on the other hand dropped 8.4% in the month of June, which was the steepest slide since February 2011. The total number of homes sold slowed to 350k from 382k while the average price fell 1.5%. Although this report is inconsistent with the recovery in housing reported by the Beige Book, the weakness is not a major surprise considering that existing home sales also declined significantly last month, which may be the reason why there was a muted reaction in the dollar. However the pullback in U.S. stocks after the number suggests that some investors are worried about the implications for Fed policy. In our opinion, the latest housing market report will not change the minds of any U.S. policymakers who know that a housing recovery will lag the broader economic recovery.

While these pieces of economic data are important, the real reason for the recovery in risk appetite is the hope for a solution for Europe. German business confidence declined in July but this did not stop the euro from rebounding against all of the major currencies. The euro has been deeply oversold in recent weeks and the magnitude of today’s recovery indicates that short covering is definitely involved. For the first time in 10 trading days, Spanish 10 year bond yields are down which is the main reason why the euro recovered. Spanish and Italian stocks also rebounded after dropping more than 10% since the beginning of the month. The catalyst was talk of a banking license for the European Stability Mechanism.

Remember, the ESM is supposed to replace the EFSF as Europe’s permanent rescue fund but the German Constitutional Court postponed their decision on approving the ESM to mid September. In other words, the ESM isn’t active yet and it will be months before a decision will be made so the support for the EUR/USD should be fleeting. Nonetheless, given the deeply oversold nature of the euro, any news was good news. To give the ESM a banking license would mean that they would be able to accept collateral from Spain, Italy and other heavily indebted nations and borrow directly from the ECB. However as borrowing costs rise, the credit quality of the ESM comes into question and in order to maintain AAA rating, significant contributions would need to be made by AAA nations who have consistently resisted greater monetary support.

Kathy Lien
Managing Director

2 thoughts on “Risk On Despite Big Drop in New Home Sales”

Leave a Reply

Your email address will not be published. Required fields are marked *