Friday, 6 July 2012

Week in Review: The Big Easing

The UK equity market continued to grind higher as investors’ worst economic fears failed to be realised.  In last week’s WIR I suggested that it might be wise to curb enthusiasm given the summit’s failure to address Europe’s main issues.  The first of these is that the bailout fund is not large enough to support the elephants in the zone: Spain and Italy. The second is that there is no meaningful stimulus being applied to arrest the decline in many European economies.

The bond markets are the barometer of the summit’s impact. Once bond investors see Spanish yields as an enticing opportunity (rather than a menacing warning) the eurozone crisis will be fixed. This week, however, the bond market’s reaction has been heavily nuanced.  The best performing market was Ireland, reflecting a combination of technical factors and the fact that, as Mike said earlier this week, policymakers have attempted to break the vicious circle between banks and sovereigns.  That link is the major problem which Ireland has.  Apart from the crippling bank bailout, Ireland entered the crisis with low level government debt and a vibrant export sector.

Like Ireland, Spain also had low government debt before experiencing a housing bubble and bust, but it also lacked growth. That distinction is enough to have made Spain the worst performing major bond market with ten year yields rapidly approaching the 7% level at which point they have needed further support from policymakers.
Source: Brewin Dolphin/DataStream

Returning to the wish-list, that would mean adding central banking power to the bailout fund, either through outright ECB purchases or the grant of a banking licence to the European Stabilisation Mechanism.
Such actions will only be undertaken very reluctantly although the European Central Bank (ECB) was at least in easy mod; lowering rates by a quarter of a percent.  In mirroring the move the Danish central bank, which ties the value of the krone to that of the euro set the rate they pay on certificates of deposit to -0.2% the first example of a negative interest rate policy that I know of (although we commented on sharply negative bond yields from Switzerland in a previous WIR).

On the same day the Bank of England left interest rates unchanged but increased its asset purchases by £50billion. 

All that was expected but China’s lowering of interest was not. We discussed before in weak is the new strong how such drastic actions by China can be indicative of weak economic news to come.  With that in mind we await next week’s trade and inflation figures with morbid fascination.

Guy Foster
Head of Portfolio Strategy

No comments:

Post a Comment