Global Briefing: Russian Turmoil Weighs on Europe

Traders are betting the prospect of peace in Yugoslavia is far off.
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European markets have tumbled in the wake of news that Russian President Boris Yeltsin summarily dismissed Prime Minister Yevgeny Primakov. Although some observers have warned that this was a possibility, it represents an intensification of Yeltsin's power struggle with Russia's parliament. The move comes ahead of new efforts by parliament to impeach Yeltsin. European markets tend to be sensitive to such political developments in Russia, but are particularly skittish because of perceptions that the political turmoil will make it more difficult to resolve the war in Yugoslavia.

The euro slipped more than half a cent to test minor support near the $1.0650 level.

Technically speaking, the break of the $1.07 level would lend credence to the double-top pattern and suggest potential toward $1.06 level in the near term. European bourses were dragged down as well. Of note, technology shares were supported by news that

Microsoft

(MSFT) - Get Report

may take a 30% stake in

Cable & Wireless

(CWP)

. Oil shares were mostly lower following yesterday's 2.4% slide in crude prices at the

New York Mercantile Exchange

and news that

Royal Dutch/Shell

(RD)

was cutting the output at its European refineries, suggesting less demand for oil.

The Russian news also added to the woes of the European bond markets

, which were lower for the third consecutive session, with 10-year bond yields rising 1-2 basis points. At 4.07%, the 10-year German bund yield stands at its highest level in two months. Continued losses in U.S. Treasury prices weigh down European bond prices. Still, the latter continues to hold up better than the former as reflected in the wide interest rate differentials.

News of a significantly stronger-than-expected German retail sales report did the bond market no favors either. As reported by the Federal Statistics Office, retail sales in March jumped 3.4% for a 6.8% year-over-year rise. The consensus had expected only a 1% increase for the month. Sales of food, drink and tobacco rose 11.7% and clothing sales rose 13.6%. But the biggest jump was in energy sales, which surged 36.2% as consumers stocked up ahead of the energy tax hikes that were imposed as of April 1. The cut in personal income taxes as of April 1 suggests German consumers may have extra disposable income and that the recovery in retail sales may continue. In a separate report, German car sales rose 23.7% in April.

NATO's war against Yugoslavia is pressuring many European coalition governments.

The strength of the German coalition could be tested as early as tomorrow. Foreign Minister Joschka Fischer, from the Green Party, threatened to resign today if his party approved a motion calling for an immediate halt to NATO's bombing at a special party Congress convening tomorrow. His resignation would threaten the tenure of the SPD-Green ruling coalition. As such the news does little to encourage investment in European assets, including the euro. Note that many parts of Europe will be closed tomorrow for a religious holiday, which may contribute to thinner-than-normal market conditions.

Japanese markets have fared better.

The

Nikkei

gained 1.22%, though it closed again below the 17,000 nemesis. Technology shares were helped by the rally on the

Nasdaq

yesterday. Pharmaceutical issues also posted healthy gains, led by

Takeda Chemical

, which reported discovering a compound that shows promise in fighting the HIV virus. Regional markets were mixed. Of note, speculation that Malaysia may reduce rates helped the

Kuala Lumpur Composite Index

post minor gains and the Korean stock market continued to pare some of its recent strong gains on profit-taking. Australia's

All Ordinaries

rose a little more than 1% on hints that

S&P

may upgrade the country's credit rating (currently double-A) over the next few days. The upgrade would follow Tuesday's budget statement that confirmed the country is poised to record a substantial surplus this year.

The yield on Japan's benchmark 10-year bond slipped 2 more basis points to 1.34%, after briefly dipping below the 1.30% level intraday. News that wholesale prices declined more than expected in April helped keep the bull market intact for Japanese bonds. Wholesale prices fell 0.3% in April for a year-over-year decline of 1.9%. Preliminary reports also suggest industrial machinery orders fell in March for the 16th time in the past 17 months. The government is due to release its comprehensive report on Friday.

In other news, several LDP legislators acknowledged that a new spending bill is likely to be considered in September and that a call for an early election is being seriously contemplated. An election must be called before October 2000, and there has been talk in recent weeks that Prime Minister

Keizo Obuchi

was leaning toward an early date, to take advantage of his improved standing in the polls and to prevent a leadership challenge from within his party. Also note that Jerry Jordan, the president of the

Cleveland Federal Reserve

, said yesterday that there was no guarantee the Japanese economy has really turned the corner.

The yen is slightly firmer today against the dollar

amid talk that Japanese exporters were buyers as they converted the proceeds of their overseas sales. Support for the dollar is seen near the lower end of the recent trading range, roughly 120.50 yen. Initial resistance is seen near the 121.20-yen level.

The U.S. Treasury sells $12 bln in new 10-year notes today.

The lukewarm reception at yesterday's five-year note sale pushed the June bond futures contract to a marginal new low. The lower-than-expected first-quarter employment cost index recently reported and than yesterday's report of a much larger-than-expected rise in first-quarter productivity should have dealt a blow to inflation fears. The fact that bond yields have not pulled back suggests that other forces are at work beside inflation worries.

Higher yields may reflect the strong demand for capital in a robust economy and not an inflation premium

per se

. In addition, the performance of competitive assets may also be sucking money from the government bond market. It doesn't have to be a portfolio shift from bonds to stocks, though that could be part of it as well. Yesterday's 10-year $7 billion bond sale by

Goldman Sachs

, for example, was well received, even after the offering size was increased. The keen interest in corporate bond offerings this year seems to suggest that investors are not boycotting fixed-income investment because of inflation fears.

Nor are commodity prices really that worrying.

The

CRB

index closed at 191.76 yesterday, compared to 191.22 at the end of last year and 221.96 at the end of last May. Though the many "talking heads" may also argue that rising yields are negative for equities, the facts belie their argument, despite what economic theories they cite. The 30-year bond yield is at its highest level since the end of last May. In the same period, the Dow Jones industrials have risen 23.5% and the Nasdaq has risen 43%. The relationship between the two is much more complicated than a simple causal or correlation link. There is no statistically significant correlation of the change in bond prices and the change in the equity indices. Without a strong correlation, causal connection cannot be reasonably claimed, even if it makes for a nice story.

Lastly, note that Brazil's April inflation was reported late yesterday well below expectations at 0.47%. This compares with a 1.28% increase in March. Brazil's central bank cut rates last Friday, for the fifth time in six weeks. On May 19 the central bank's policymaking committee meets and another rate cut should not be surprising. That said, because interest rates are in a clear downtrend, the central bank president has the discretion to cut rates independently of the committee.

Marc Chandler is an independent global markets strategist who writes daily for TheStreet.com. At the time of publication, he held no positions in the stocks, currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at

commentarymail@thestreet.com.