Euro-zone problems continue

Earlier in the week, we found out that the euro-zone unemployment rate held at a record 12.0% in February, highlighting the difficult problems being faced by policy makers on the other side of the Atlantic.



Today, the European Central Bank offered little comfort with the exception of touting its past achievements that have kept the woefully under-capitalized banking system from blowing apart at the seems.

I guess we really should be thankful for small favors.

ECB President Mario Draghi still believes the euro-zone will experience  a gradual recovery in the second half of the year, but he added a caveat - that any recovery is “subject to downside risks.”

It sounds as if he may be losing a little faith in his own forecast. At 75 bp, monetary policy is accommodative, but he’s not offering much more stimulus.

A rate cut was discussed “extensively,'” but a 25 bp or even a 50 bp rate reduction would be mostly symbolic. And don’t expect much in the way of fiscal stimulus.

Europe’s in a mess, and its weak banking system isn’t in a position to supply needed credit.

All this shouldn’t be lost in the U.S. investor. Sure, the market has pierced all-time highs, but weak sales in Europe seem likely to hinder profits at home.

Keep an eye on comments from the multinationals, as they report profits.

Cyprus keeps it interesting

We watch Europe quiet down, at least for a while, and then problems resurface. This time it's Cyprus.

The European Central Bank has done a remarkable job of holding the financial system in Europe together, but what is truly needed is economic growth. Until the recession in Europe ends, its under-capitalized banking system will remain under considerable stress.

Still, muted market reaction in the U.S and in Europe - a lack of reaction in Spanish and Italian debt yields - is signaling a lack of anxiety over contagion.

Monday is the deadline for Cyprus to accept German/IMF terms. If Cyprus rejects, its banking system will collapse, and we will likely see some renewed volatility, as the market tests ECB President Draghi's pledge to do whatever it takes to preserve the euro.

If Cyprus cries "uncle" (it really doesn't have much choice and that is what markets are pricing in), we limp through the latest euro-zone debt crisis.

Cyprus hopes to trip up the bulls

Over the weekend, news broke that Cyprus will levy a tax on its depositors to help with a bailout of its faltering banking system.

Not surprisingly, we saw a run on ATM machines in the country, but no bank lines as the financial institutions were closed today and are expected to be closed until Thursday.

The uncertainty created by the situation on the tiny island in the eastern Mediterranean shook global markets amid concerns that we might evenutally see a repeat in larger countries like Spain or Italy. The last thing we want to see is Italian depositors lining up around the block, demanding their life savings.

Stocks in the U.S. opened lower but pared losses by the close. In a flight to safety, Treasuries jumped as trading began but came off highs as cooler heads prevailed. Even better, junk bond fund fully recovered from early losses. Want a canary in the cold mine? High-yield funds are the closest you'll get.

What we saw today was an attempt by U.S. markets to sort through the noise.

But let's take a step back. Cyprus is barely 0.25% of euro-zone GDP, and countries such as Greece, Italy, Spain, Portugal, and Ireland have failed to sink the euro.

I don't have a crystal ball, but it seems unlikely that a cataclysmic euro-zone event might originate with Cyprus. Volatility? Probably. Stocks never move in a straight line.

Bottom line - Europe's problems have subsided and the relative calm in the credit markets has been a boon to U.S. stocks - think the removal of a roadblock. As we saw today, euro-zone woes haven't been put to rest.

The Dow tops a psychological milestone

The bulls have been gunning for the Dow’s all-time high for several weeks, and on Tuesday, positive sentiment finally helped the oldest and best known of the major market averages close above a threshold that hadn’t been seen since Oct 2007.

Yes, it may be just a psychological barrier, but it’s one that gets plenty of attention. And today, in a rocky session, the Dow added another 42 points.

General themes that have been driving equities higher include:

· Slow but steady economic growth

· Profits are topping a low hurdle

· Quieter credit markets in Europe (more of a removal a roadblock)

· The search for yield

· A very accommodative Fed policy

· The renewed interest in LBOs and mergers

· A sense that China’s economy won’t stall

· Europe is expected to exit its recession later in the year

· The fiscal cliff was avoided at the beginning of the year.

Are there risks? You bet. Some include the possibility that European credit markets could flare-up again, China could experience a hard landing, or the U.S. recovery could stall.

Cliff diving

Bad news continues to dribble out of Europe, and there is always the ever-present worry about corporate profits and how the global economic slowdown will hit the bottom line.

But the major players in the upcoming fiscal negotiations appeared to be digging in their heels on Wednesday, suggesting a protracted battle is brewing over the fiscal cliff.

That’s not what the Street wants to hear. Still, it shouldn’t come as a surprise as an emboldened president and a tax-averse House Speaker unveil their opening positions.

On Friday, a meeting of top Democrats and Republicans ended on a more conciliatory note in what are sure to be difficult talks.

Looking skeptically at September’s unemployment rate

The unemployment rate unexpectedly fell in September by three ticks to 7.8%. Most economist had anticipated an unchanged reading or a small rise to 8.2%.

In the meantime, nonfarm payrolls rose by a muted 114,000 last month. That was generally in line with expectations given the weak economic recovery. Further, the private sector managed to generate just 104,000 jobs.

So what gives? Why the outsized drop in the politically sensitive indicator?

The unemployment rate did not decline due to discouraged job seekers leaving the job market, which has occurred in some of the prior reports.

In fact the rolls of the employed rose by an astounding 873,000 (including 582,000 part-time workers), according the the household survey!



Quirks in seasonal adjustments?
The last three years have recorded outsized gains in part-time employment September, which then washes out in October.




The BLS might want to review their statistical models.

The Fed–shoot now, ask questions later

The markets had anticipated the Fed would act, but the magnitude of the FOMC’s open-ended commitment to increase its balance sheet was met with a bullish stampede today.

And it wasn’t just stocks. Oil, gold and a host of other commodities gained ground.

The Fed is trying to reflate, and it won’t stop until it sees substantial progress in the labor market. In fact, the Fed’s statement was clear:

“If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”

So it's not just looking for improvement. The Fed will continue its bond purchases until it sees "substantial improvement."

At least publicly, it does not believe it will materially add to inflation, but the key question is whether its latest path will aid the economy and move the needle on the unemployment rate.

QE1 and QE2 - or $2.3 trillion in bond buys - have failed to significantly lift the economy. Bernanke even acknowledged in his press conference that "I don't think our tools are that strong."

The Fed chief has said before that monetary policy is not a panacea, but that was an interesting remark as the central bank embarks on a new chapter.