Europe now in the spotlight as investors switch focus

Yesterday's European trading session highlighted several themes that will dominate the agenda over the coming months.

Greece is the word

Greek prime minister Antonis Samaras has told his new cabinet that they must meet the targets set with the Troika, if Greece is to avoid even more austerity.
Samaras also made growth, employment and stability the priorities as he looked to grab the political momentum back after the turmoil caused by the closure of state broadcaster ERT earlier this month. Under a barrage of political and economic turbulence, Greek policymakers have a tight rope to walk as they try to guide the country back to financial health. The problem is that the demands being placed on the country (by the EU/IMF) are growing while Greek fundamentals are deteriorating. The reason the IMF is demanding more is because alot of the rosy Greek budget figures were dreamt up in the first place, and the reason Greek GDP/unemployment/wages are deteriorating is because austerity measures are being enforced crudely and unequally. Usually targeting low income workers and unions rather than high income, tax dodging industries such as banking and HNW's. The result is public discontent, political uncertainty, delays, unpaid debt and higher bond yields which forces more ECB support.

With Greek political problems being known to cause problems for the EUR in the past, this theme may still rise up and halt EUR strength. Greek recovery is slow and likely to disappoint on several fronts before any kind of finality is achieved in its persistent debt troubles.

Bonds are back

Italy and Spain both saw their borrowing costs rise at debt auctions yesterday in the European session, raising fears that the market turbulence is weighing on weaker EU nations in the periphery. Spain sold €930m of three-month bills with an average yield of 0.869%, up from 0.331% at the last auction, and €2.14bn of nine-month bills at a yield of 1.441%, up from 0.789%. Demand for the 3-month bills was down sharply (a bid-to-cover ratio of 2.9 vs. 4.3), but the Spanish Treasury did receive slightly more bids for the longer-dated bills compared to the previous auction. In Italy borrowing costs jumped at an auction of €3.5bn of 2yr bonds. Buyers of the debt demanded yields of 2.4%, up from a record low of 1.1% last time.

Spain and Italy have seen some relief this year with borrowing costs falling steadily due to ECB stimulus measures containing rising bond yields. ECB bond buying has put a floor even under distressed government debt from countries such as Greece, Spain and Italy. However, following the Fed’s announcement of planned tapering later this year or 2014, investors are realising that European debt markets are now entering a much more volatile phase compared to previous instances of uncertainty.

In some respects, the market influence wielded by the Fed in North America is now affecting European expectations as evidenced by rising bond yields and falling demand for EU debt, merely a week after the Fed signalled its diminishing appetite for asset purchases. It seems that even major non-US markets such as the Eurozone (not to mention swades of developing markets) were largely supported by Fed policy over the past 5 years. Fears are growing amongst investors, policymakers and market commentators alike - just what adverse effects could occur if a withdrawal of liquidity actually takes place? For the time being, liquidity withdrawal is only an expectation which has been followed up by speculative market actions from a limited number of market participants as invesotrs still try to gauge what all this means for markets. Hedge funds, prop trading desks and large investors are still largely sidelined after last week's sharp moves - focusing more so on continuing their gradual deleveraging than initiating new long term positions.

One other bit of news from Europe overnight was the seven year jail term and public office ban for Silvio Berlusconi. Although this is a non-financial story, the impact may still be important because the whole issue and subsequent public reaction is putting pressure to Italy’s fragile coalition. More division is likely to lead to a split, new elections and more uncertainty as to whether Italy will keep up its ECB/EU/IMF austerity plan. Given Italy’s size, EUR pairs would likely take the brunt of investor displeasure.

Stock market smiles

Stock markets staged small revivals across Europe yesterday. Helped by a raft of central banker comments and better US data. The DAX led gains with +1.55%, followed by FTSE (+1.2%), CAC (+1.5%) and IBEX (+0.7%). Italian stocks bucked the trend, falling 0.37%.

US Data showed further strength and fits in with Fed expectations of a gradual recovery - for now.

Durable Goods orders (3.6% vs. 3.0% exp.)
Core Durable goods orders (0.7% vs. 0.0% exp.)
CB consumer confidence 81.4 vs. 75.2 exp.
New home sales 476,000 vs. 462,000 exp.
S&P/CS Composite HPI 12.1% vs. 10.6% exp.

Even two weeks ago, strong macroeconomic data from the U.S. may have weakened U.S. stocks and the USD because investors were more concerned over what the news is likely to mean for the mammoth stimulus programme being enacted by the Fed. Since the confirmation and promotion of the fact that Fed support is not permanent and will eventually cease , there is a slow return back to normality as investors digest US data in a more traditional way. i.e. good US data means a better US economy thus stocks/USD rise.

China

The PBOC was on the wires, stating:

"If banks have temporary shortages in their planned funding, the central bank will give them liquidity support"

"If institutions have problems in managing their liquidity, the central bank will apply appropriate measures under the circumstances to maintain the overall stability of money markets"

No signs of PBOC tapering in China (or at the Bank of England, Bank of Japan, or SNB for that matter). These comments helped markets take on a more risk friendly tone and allowed AUD/USD to find some ground, touching a weekly high of 0.93.

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Commissioned by Think Forex

Written by George Tchetvertakov

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