Deflation Abounds, Bears Abide

The sell-off that began with the Fed’s downbeat economic assessment and underwhelming policy response circled the globe overnight and appears ready to pick up when U.S. markets reopen. What’s stunning is that the plunge has taken in everything from Hong Kong stocks to commodities, with U.S. Treasuries the only safe haven.

European bourses are getting crushed with the Euro Stoxx 50 down a huge 5%. Banks are at the epicenter of the selling, exacerbated by Standard & Poor’s downgrade of Italian banks following the rating agency’s cut in Italy’s sovereign debt. That followed Moody’s downgrade Wednesday of big U.S. banks, in part on the expectation they could expect less support from the government in the future, meaning they might no longer be too big to fail. The Fed’s so-called Operation Twist is seen hampering bank earnings by flattening the yield curve and narrowing banks’ profit margins between the short-term rates they pay and the yields on their assets.

While Europe’s sovereign debt crisis remains an omnipresent source of worry, the key factor is the mounting signs of a global economic slowdown. That was especially apparent in the 3% plunge in South Korea’s Kospi, which was pressured both by the gloomy U.S. outlook and news that China’s manufacturing sector contracted for the third straight month.

The dollar again is sought as a global safe haven while commodities slump, not only actively traded ones such as copper but also other economically vital ones such as coal. Crude oil is down $3.62 at $82.30 a barrel while gold is shedding about $50 at $1755 an ounce. Deflation’s impact also is visible in the Treasury market with yields falling to modern records, 1.77% on the 10-year note and 2.86% for the 30-year bond.

As Barry Ritholtz of Fusion IQ sums it up: “With the Fed out of bullets, traders are now left to their own devices. That means decelerating growth, little in the way of new hiring, and peak profits retreating 15-25%. There is no cavalry coming over the hill, traders are on their own. Next stop [S&P 500] 1100, with 950 as a realistic downside target.”