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• European belt tightening directs play.
• “Green shoots” are hard to come by.
• Volatility rife and liquidity dries up.

In a week in which Tony Abbott demanded discipline in the party room, the same was likely being said by ECB President Jean-Claude Trichet regarding fiscal tightening in Europe. Italian PM Silvio Berlusconi showed restraint by removing political largess when he approved EUR 24B in cuts to the budget, however the theme of budget cuts being in Vogue was not continued in Spain. Spain has a budget deficit more than twice that of Italy at 11.2% of GDP and was criticised by the IMF for not going far enough on budget cuts. There are lingering concerns regarding possible sovereign debt defaults in Europe however recent belt tightening is reducing that risk and has been positive for the Euro this week. The Euro has been arresting earlier losses while the Eurozone constrains appetite for riskier assets as global growth forecasts are revised downwards.

US economic data failed to provide the lead equity markets required, with some relatively soft economic data highlighting that “green shoots” are still hard to come by. Most notably, Initial Jobless Claims were 471K, and Leading Indicators -0.1%, both of which were significantly down on expectations. Risk aversion is hampering growth in the local currency as the market deciphers whether a bull or bear market will continue or whether moderate growth prospects will envelop a neutral weighting on risky assets. The S&P 500 is down 9.49% for May to date.

The levels of volatility we’ve seen this past week in the AUD has been reminiscent of 2008, however last night’s sudden bounce for the DOW may suggest a floor has been found in the equity markets. The amount of volatility in the market has been increasing with the key volatility index reflecting increasingly higher costs for S&P 500 options. This coupled with reduced levels of liquidity in the market had provided for the perfect environment for the heady losses to the Aussie. This has resulted in speculation the RBA may use foreign currency reserves to increase liquidity and provide support for the local currency as it did in 2008.

The existing undercurrent of soft European and US economic data is not providing support for equity markets which have been looking particularly tentative along with the risk-correlated Aussie dollar.