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ECB still has a major role to play 7 Aug 2012 For the week, the Dow Jones Industrial Average climbed 0.2% to 13,096, the S&P 500 Index advanced 0.4% to 1,390 and the Nasdaq Composite rose 0.3% to 2,967. With these gains, stocks closed the week at a three-month high and are now up over 10% on a year-to-date basis. Since late May the MSCI World Index has risen by 10% in local currency terms, although that only put it back to where it started in early May. Trading has been very volatile - European equities have rallied strongly over recent sessions, and moves of 3% in one day have been common. The more conservative companies have continued to lead the equity rally over the past couple of months, rather than the high volatility, riskier stocks. This supports the notion that investors are not buying into a fully-fledged, growth-led recovery story. Elsewhere, bond yields have generally stabilised. Despite the recovery in equity markets, US and German 10-year benchmark bond yields have risen by about 25 basis points over the past few weeks, while UK yields have been pretty constant. There have been some interesting divergences in commodity markets - industrial metals values remain at very low levels with no sign of any upward momentum, while oil and gold have been volatile, albeit within well-defined trading ranges. There has been a substantial recovery in agricultural prices, largely reflecting supply-side pressures. ECB still has a major role to play It has been apparent throughout the euro zone crisis that the European Central Bank (ECB) has a major role to play in resolving it, as its balance sheet is big enough to make a major impact, should it decide to use it. The central bank has more recently become concerned about the breakdown of the monetary transmission system in Europe, particularly as high-risk premium for Spanish bond issues mean the ECB is unable to set monetary policy that works across all euro zone countries. The ECB has made it clear it will intervene again to buy the debt of troubled peripherals, but only after a formal request has been made by the relevant nation for either European Financial Stability Facility (EFSF), or European Stability Mechanism (ESM) support.


Even then, the ECB has made it clear such support is not automatic - it would be conditional on the appropriate fiscal or structural measures being taken by the nation requesting help. The ECB’s previous concern had been that buying bonds without any reciprocal policy action from the nations in question was reducing pressure for fiscal consolidation in southern Europe, potentially transferring all of the fiscal risk onto the ECB’s own balance sheet. Insisting on national policy action, apart from being more politically palatable for the ECB, would also be more acceptable to some of the northern European countries. It’s interesting that German Chancellor Angela Merkel appears to have come out in support of this move, although the Bundesbank has been resistant to it. The ECB has also stated that it will examine the issue of the seniority of its own holdings of peripheral debt relative to other borrowers. Since late May the MSCI World Index has risen by 10% in local currency terms, although that only put it back to where it started in early May. Trading has been very volatile - European equities have rallied strongly over recent sessions, and moves of 3% in one day have been common. The more conservative companies have continued to lead the equity rally over the past couple of months, rather than the high volatility, riskier stocks. This supports the notion that investors are not buying into a fully-fledged, growth-led recovery story. Chance of another European rate cut However this is not the end of the European sovereign crisis as there is still uncertainty over the details. There are also other issues to be addressed, such as the size of the EFSF and ESM, and the role of a more centralised fiscal policy across Europe. All of this is occurring against a backdrop in which the region’s recessionary pressures remain worrying. But it is certainly a step in the right direction, and it seems likely that more measures of support will be coming from the ECB in coming weeks. These include the possibility of another rate cut, a change in policy on collateral management, and potentially another Long-Term Refinancing Operation. Macro background is still murky It’s important to stress that Europe hasn’t been the only issue for global equity markets. The world economy has been slowing since early Spring and although recession is only apparent in Europe, this trend has had implications for risk assets. It is fair to say that the macro background is rather mixed and murky. Outside Europe, key themes are that manufacturing appears to be slowing - although not disastrously so and that inventories appear to be high while orders are weak, particularly in Asia. However, services sectors do appear to be faring better, as seen in the US non-farm payrolls figures which surprised on the upside on Friday. The global economy may now be stabilising at a relatively low level of growth with little sign of any material acceleration, although this may eventually come through with the fall in commodity prices and policy easing in emerging markets.


Currencies On currency markets, the dollar weakened against most major currencies as risk appetite increased amid speculation that central banks will take action to boost economic growth. The €/$ rate gained marginally, ending the week at €1.24.

Oil Oil prices surged by the most in a month after US job creation rose and its service industry expanded faster than expected. Prices rose by 2.4% to finish at $92 a barrel. Gold prices finished the week lower but rose on Friday after speculation that the commodity’s worst week in six would spark some buying.

Bonds Spanish two-year bonds rose, pushing the yield down by the most in 2012, on speculation that the ECB would buy shorter-maturity bonds to try to ease the region’s debt crisis. The country’s 10-year bond yield also fell, moving below the critical 7% level. Italian bond prices also rose. Overall, the index rose marginally as German bunds swung between gains and losses amid concern about the nation’s opposition to further debt purchases by the central bank. The Merrill Lynch over 5 year government bond index ended the week 0.4% higher.

ECB Still Has A Major Role To Play  

Since late May the MSCI World Index has risen by 10% in local currency terms, although that only put it back to where it started in early Ma...