The trading tone on stock markets this week will likely be determined by the reaction of global financial markets and ratings agencies to a proposed EU mechanism to deal with Europe’s government debt crisis once and for all.
The TSX ended last week little changed after all but one of the European Union’s 27 member countries signalled they’re open to joining a new treaty tying their finances closer together to avoid a repeat of the currency euro crisis.
Britain turned thumbs down on the proposal, saying such a treaty wouldn’t be in its interest. The U.K. is one of the EU members that still uses its own currency, rather than the euro.
“We’ve seen this before, where it looks like Europe has finally nailed things down and then doubts creep back into the markets,” said Doug Porter, deputy chief economist at BMO Capital Markets.
“Let’s just say it’s far too early to declare the all clear.”
The new eurozone treaty calls for participating governments to have balanced budgets, which will require constitution amendments. An unspecified “automatic correction mechanism” would punish countries that break the rules.
In addition, countries that run deficits larger than three per cent would face sanctions.
There will be some diversion from Europe woes in the form of the latest reading on the American economy from the U.S. Federal Reserve and U.S. retail sales data in an attempt to gauge the health of the holiday shopping season.
The flat performance on the TSX last week was misleading since the market surged more than five per cent during the previous week on hopes that the EU summit would come up with a satisfactory mechanism to deal with the crisis.
The deal reached last week is a long term solution and markets have looked for a more immediate response to the debt crisis.
Some have looked to the European Central Bank to take a more active role, possibly by buying up more government debt in the markets to lower borrowing costs for more heavily indebted countries such as Italy and Spain.
But sentiment took a hit on Thursday before the start of the summit after European Central Bank president Mario Draghi suggested he had no intention of increasing bond purchases.
“The bad news for the markets was that the ECB has no appetite for expanding their bond purchases and this is ultimately why the markets were rallying before,” said Porter.
Traders will also be looking to an announcement from ratings agency Standard & Poor’s, which warned last week prior to the summit that it may downgrade the triple A rating of the 27-nation European Union.
The ratings agency said it was placing the EU’s AAA long-term rating on creditwatch negative.
Earlier in the week, S&P put a large number of the 17 euro countries on notice for a possible downgrade, including Germany and France.
Any downgrade would be serious as they usually lead to higher borrowing costs.
“The criteria was that there would have to be some pretty concrete steps taken in terms of a fiscal compact,” said Mark Chandler, head of Canadian FIC Strategy at RBC Dominion Securities
“The worrying point is that there is still a lot to be decided prior to March (when officials want a new treaty ready) and there is still some question marks about how it will get incorporated, whether a referendum would be required, be part of the constitution.”
Chandler suggested markets won’t have to wait long for the rating agency’s verdict.
“They would be surprised if within the next week they didn’t hear anything,” he said.
Meanwhile, the U.S. Federal Reserve makes its next announcement on interest rates on Tuesday. The Fed has already promised to keep rates near zero for some time to come and analysts say the Fed is not expected to announce any stimulus measures.
“Our best guess is that the Fed does stay on the sides for the meeting this go round.”
Economists also expected a positive reading from November retail sales data which also comes out Tuesday.
Porter noted that early indications for a decent holiday retail season were relatively positive from both the strong sales seen after Black Friday, the day after American Thanksgiving and the start of the holiday shopping season.
He also pointed to solid auto sales during November.
One of the rare bits of good news in recent months is that the U.S. consumer looks to be slowly but surely getting back on their feet despite the intense global financial market turbulence we have been through in recent months, said Porter.
But traders will be anxious to see the Fed’s latest take on economic conditions.
“While there are mounting concerns about Europe, that’s offset by somewhat better than expected outcome in the U.S. economy,” said Porter.
The only Canadian data of note for this week is the October reading on manufacturing shipments.
Economists expect shipments slipped 0.1% following a strong 2.6% surge in September.
The dip would reflect weakness in the auto industry, which has experienced supply disruptions from Thailand, which has been plagued by heavy flooding.