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PR Newswire
03-02-2012, 01:09 PM
January 30th 2012
FROM THE EconOMIST INTELLIGENCE UNIT
Risky-asset markets have made big gains since the start of the year, recouping part of the losses seen in the second half of 2011. The rally started in equity markets but has broadened to encompass credit markets, commodities, currencies and emerging-market assets. Although serious threats to this rally remain—most notably in the form of concerns about the effectiveness of policy efforts to stabilise the euro zone—for the time being there are a number of reasons to expect the surge in risk appetite to continue.
The most important factor in the rally in risky markets has been the European Central Bank's offer of cheap three-year loans to euro zone banks in late 2011. Banks took up almost the entire allotment of funding (€489bn out of a total of €500bn). After taking into account repayment of short-term ECB funding, a net €200bn (US$260bn) was injected into the euro zone financial system in December. The ECB has announced that it will make another offer of three-year repos in late February.
The ECB repos have eased conditions in funding markets for peripheral banks and sovereigns. Euro zone banks from core countries have issued unsecured debt for the first time in several months, and Spanish banks have issued secured debt. Fears that euro zone banks would not be able to roll over an estimated €600bn in long-term debt repayments in 2012 have receded.
Crucially, the improvement in bank funding markets is filtering through to sovereigns. Italy is a particular concern, as the government needs to raise around €320bn this year, including €97bn to cover bonds falling due between February and April. Yet Italy and Spain have seen borrowing costs at auctions of short-term money halve from the levels paid in December. And auctions of 7-year and 10-year Spanish bonds have met with higher demand than expected.
Long-term rates remain uncomfortably high for Italy, but they have fallen from a peak of above 7% to just under 6% in late January. Moreover, this decline has occurred without much support on the part of the ECB, which is thought not to have expanded its programme of government bond purchases materially during January. The rally held up in the face of euro zone sovereign rating downgrades by Standard & Poor's, a credit-rating agency, earlier in the month. This included stripping France of its AAA rating, which reduced the lending capacity of the European Financial Stability Facility, the euro zone's rescue fund.
Developments elsewhere have been mostly supportive of risky assets. In the US manufacturing data have been strong, and average monthly job creation has been running at around 170,000, which is consistent with a decline in the unemployment rate. Corporate earnings in early 2012 have been falling short of expectations, but the market is rallying in the face of this, indicating a rerating of equities.
Record low interest rates on both cash and government bonds are pushing investors into riskier asset classes. The US Federal Reserve indicated in late January that it will keep interest rates at exceptionally low levels until late 2014 (previously it had said rates would stay low until mid-2013). More investors are also now expecting the Fed to undertake another programme of quantitative easing (QE). In the UK the Bank of England is expected to launch another round of QE, buying £75bn (US$117bn) of gilts.
In China the tone of data has improved after some below-par releases in late 2011 (though the economy may well be weaker than headline GDP growth suggests). At the same time, the Chinese authorities have started to relax monetary policy, and, given declining inflation, further mild easing is in prospect in 2012. Generally the focus of emerging-market central banks has shifted from inflation to growth. Several, including Brazil, are now easing monetary policy; others have stopped monetary tightening and interest rates are now on hold.
Will it last?
How sustainable is the current rally in risky assets? Although monetary policy is supportive, it will not be sufficient if any of the dire prognoses about the world economy were to materialise.
In the euro zone the ECB's actions, powerful as they are, ultimately do no more than buy time. The onus is on euro zone governments, which—if they want the single currency to survive—will have to accept closer fiscal union, including some form of pooling of sovereignty. Even this would not resolve the structural issue of whether peripheral countries can regain competitiveness and grow within the constraints of monetary union. And Greece will remain a potential source of contagion given the failure of the EU/IMF loan programme to restore confidence in the country's solvency. There is a risk of a disorderly default unless an agreement is reached on debt restructuring with private creditors and the EU and IMF grant Greece another loan package. Greece faces bond repayments of €14bn as early as mid-March.
Worries about whether the Chinese authorities can engineer a soft landing are also set to persist as prices of high-end properties in coastal cities probably have some way to fall.
Given these concerns, risk-averse investors might now be inclined to take money off the table. But after negative returns for most investors in 2011, fear of missing out on a rally may trump caution, particularly given the meagre yields on cash and safe-haven bonds. Equity yields in developed markets are comfortably above those on government bonds, offering investors a decent premium for assuming risk.
Sentiment, often a contrarian indicator, remains cautious. At the start of the year strategists were bearish about prospects for 2012. This risk-averse attitude was reflected in crowded bearish positioning across a range of markets—including foreign exchange, where bets in favour of the US dollar against the euro were at record levels. Positioning has become less extreme since the start of the year, but investors remain sceptical of the rally. This could provide the fuel for further gains if bears are forced to close short positions or buy the market.
It is said that markets climb a wall of worry. There is no shortage of concerns in today's world, but part of that is already priced in. Given the prospect of another injection of ECB liquidity at the end of February and the lengthening odds on an imminent break-up of the euro, the rally looks set to continue for a while yet. The going is likely to get harder in the second quarter, when concerns about growth in the euro zone and the developed world more generally may come to the fore.
FROM THE EconOMIST INTELLIGENCE UNIT
Risky-asset markets have made big gains since the start of the year, recouping part of the losses seen in the second half of 2011. The rally started in equity markets but has broadened to encompass credit markets, commodities, currencies and emerging-market assets. Although serious threats to this rally remain—most notably in the form of concerns about the effectiveness of policy efforts to stabilise the euro zone—for the time being there are a number of reasons to expect the surge in risk appetite to continue.
The most important factor in the rally in risky markets has been the European Central Bank's offer of cheap three-year loans to euro zone banks in late 2011. Banks took up almost the entire allotment of funding (€489bn out of a total of €500bn). After taking into account repayment of short-term ECB funding, a net €200bn (US$260bn) was injected into the euro zone financial system in December. The ECB has announced that it will make another offer of three-year repos in late February.
The ECB repos have eased conditions in funding markets for peripheral banks and sovereigns. Euro zone banks from core countries have issued unsecured debt for the first time in several months, and Spanish banks have issued secured debt. Fears that euro zone banks would not be able to roll over an estimated €600bn in long-term debt repayments in 2012 have receded.
Crucially, the improvement in bank funding markets is filtering through to sovereigns. Italy is a particular concern, as the government needs to raise around €320bn this year, including €97bn to cover bonds falling due between February and April. Yet Italy and Spain have seen borrowing costs at auctions of short-term money halve from the levels paid in December. And auctions of 7-year and 10-year Spanish bonds have met with higher demand than expected.
Long-term rates remain uncomfortably high for Italy, but they have fallen from a peak of above 7% to just under 6% in late January. Moreover, this decline has occurred without much support on the part of the ECB, which is thought not to have expanded its programme of government bond purchases materially during January. The rally held up in the face of euro zone sovereign rating downgrades by Standard & Poor's, a credit-rating agency, earlier in the month. This included stripping France of its AAA rating, which reduced the lending capacity of the European Financial Stability Facility, the euro zone's rescue fund.
Developments elsewhere have been mostly supportive of risky assets. In the US manufacturing data have been strong, and average monthly job creation has been running at around 170,000, which is consistent with a decline in the unemployment rate. Corporate earnings in early 2012 have been falling short of expectations, but the market is rallying in the face of this, indicating a rerating of equities.
Record low interest rates on both cash and government bonds are pushing investors into riskier asset classes. The US Federal Reserve indicated in late January that it will keep interest rates at exceptionally low levels until late 2014 (previously it had said rates would stay low until mid-2013). More investors are also now expecting the Fed to undertake another programme of quantitative easing (QE). In the UK the Bank of England is expected to launch another round of QE, buying £75bn (US$117bn) of gilts.
In China the tone of data has improved after some below-par releases in late 2011 (though the economy may well be weaker than headline GDP growth suggests). At the same time, the Chinese authorities have started to relax monetary policy, and, given declining inflation, further mild easing is in prospect in 2012. Generally the focus of emerging-market central banks has shifted from inflation to growth. Several, including Brazil, are now easing monetary policy; others have stopped monetary tightening and interest rates are now on hold.
Will it last?
How sustainable is the current rally in risky assets? Although monetary policy is supportive, it will not be sufficient if any of the dire prognoses about the world economy were to materialise.
In the euro zone the ECB's actions, powerful as they are, ultimately do no more than buy time. The onus is on euro zone governments, which—if they want the single currency to survive—will have to accept closer fiscal union, including some form of pooling of sovereignty. Even this would not resolve the structural issue of whether peripheral countries can regain competitiveness and grow within the constraints of monetary union. And Greece will remain a potential source of contagion given the failure of the EU/IMF loan programme to restore confidence in the country's solvency. There is a risk of a disorderly default unless an agreement is reached on debt restructuring with private creditors and the EU and IMF grant Greece another loan package. Greece faces bond repayments of €14bn as early as mid-March.
Worries about whether the Chinese authorities can engineer a soft landing are also set to persist as prices of high-end properties in coastal cities probably have some way to fall.
Given these concerns, risk-averse investors might now be inclined to take money off the table. But after negative returns for most investors in 2011, fear of missing out on a rally may trump caution, particularly given the meagre yields on cash and safe-haven bonds. Equity yields in developed markets are comfortably above those on government bonds, offering investors a decent premium for assuming risk.
Sentiment, often a contrarian indicator, remains cautious. At the start of the year strategists were bearish about prospects for 2012. This risk-averse attitude was reflected in crowded bearish positioning across a range of markets—including foreign exchange, where bets in favour of the US dollar against the euro were at record levels. Positioning has become less extreme since the start of the year, but investors remain sceptical of the rally. This could provide the fuel for further gains if bears are forced to close short positions or buy the market.
It is said that markets climb a wall of worry. There is no shortage of concerns in today's world, but part of that is already priced in. Given the prospect of another injection of ECB liquidity at the end of February and the lengthening odds on an imminent break-up of the euro, the rally looks set to continue for a while yet. The going is likely to get harder in the second quarter, when concerns about growth in the euro zone and the developed world more generally may come to the fore.